Managing Currency Risk in Your Investments
April 8, 2016
Geographic diversification is an important portfolio building tool that can help investors improve returns and manage risks. While investing beyond Canadian borders offers many advantages, it’s important to be aware of the risks involved.
Currency risk: A key factor in foreign investing
Currency risk (or exchange-rate risk) exists because foreign investments are priced in foreign currencies. When the foreign currency in question appreciates or depreciates against the Canadian dollar, the total return of the foreign investment is impacted.
Consider this example:
As illustrated above, when the foreign currency depreciates relative to the Canadian dollar, the result is a lower valuation of the foreign investment when measured in Canadian dollars. Conversely, when the foreign currency appreciates against the loonie, the result is a higher valuation.
The following table shows annual returns of several foreign currencies against the Canadian dollar. These returns are driven by a variety of factors, including monetary policy and sensitivity to economic events.
As you can see, foreign currencies can be a source of both risk and opportunity for an investment portfolio. Much like with the markets, minimizing the risks and taking advantage of the opportunities require expertise.
While studies have suggested that over the long term, currency returns are expected to be negligible, in the short to medium term, they can have significant influence.
The Canadian dollar remains in headlines
Much attention has been paid to the Canadian-U.S. dollar exchange rate over the past five years as the loonie has taken a big slide. Since the period of currency parity, the Canadian dollar has declined dramatically relative to the U.S. dollar and it recently dropped below 70 cents. It has since bounced back to the mid-70 cent range.
The recent rally may be short-lived, as we expect the Canadian dollar to decline again over the short term due to low energy prices. However, the next drop will likely be the worst of it as the loonie’s undervaluation will start to provide support. The dominant industry outlook is that the Canadian dollar will bottom out around 65 cents, its 14-year historical low, followed by a long consolidation phase. Should this happen, MD Financial Management may look to reduce U.S. dollar exposure by hedging.
How does MD manage currency?
MD is owned by the Canadian Medical Association, and its core mandate is to improve the financial outcomes of physicians. To do this, we consider and actively manage all aspects of our clients’ financial well-being. MD has implemented a sophisticated, dynamic currency program for MD funds that manages more than 30 currencies daily. This is all part of the comprehensive, physician-focused investment advice we provide.
MD PrecisionTM is MD’s forward-looking management process that allows us to provide clients with truly world-class asset management. It is based on disciplined oversight, objective evaluation and unbiased decision-making. Part of MD Precision is selecting world-class asset managers whose expertise will help our clients achieve their financial goals.
MD employs the currency expertise of CIBC Asset Management. It has a long track record of managing currencies, and it employs a strict process built around a unique quantitative model, supported by experience, sound judgment and rigorous analysis.
MD’s currency management strategy provides an intelligent decision-making framework that enables us to determine how and when currency exposure takes place. CIBC Asset Management adjusts the foreign currency exposure depending on its evaluation results. This is a significant advantage over the passive strategies (fully exposed or fully hedged) employed by other asset managers; it provides MD’s clients with another opportunity for diversification, potentially enhanced returns and better risk management.
For more information about the impact of foreign currencies on your investment portfolio, contact an MD Advisor. MD offers objective advice at every stage of your career—from medical school through retirement. Find an MD Advisor near you.