How foreign-exchange exposure benefits Canadians

Canadians must invest globally to achieve sufficient diversity in their portfolios, which may create unease about the negative impact of currency fluctuations on retirement savings. Slava Kulesh, senior research analyst, investment management research at CIBC, puts currency volatility in perspective.

Listen to the full podcast on AdvisorToGo, powered by CIBC.

“Currencies tend to fluctuate quite a bit in the short run,” says Kulesh. “In the long run, they’ve actually been pretty stable.”

For example, an investor exposed to the U.S. dollar, euro and yen over the last 25 years would have experienced negligible portfolio impact from currency volatility.

Why? For starters, currency fluctuations tend to neutralize in the long run.

“The Canadian dollar might depreciate relative to the U.S. dollar and the euro, but then appreciate relative to the Japanese yen,” says Kulesh. “So that would cancel out those impacts.”

In fact, for a Canadian investor, the annualized absolute impact of exposure to those three prominent currencies—the U.S. dollar, euro and yen—is only 0.1% over the last 25 years on average, says a CIBC report that Kulesh co-authored.

Despite short-term fluctuations, currencies “tend to hover around a stable value […] determined around relative costs of living, which tend to be rather stable from one country to another,” says Kulesh. “So we do see more stability in long-term periods of currencies compared to short-term periods.”

While these effects can reassure long-term investors about currency volatility, Kulesh highlights another important observation: foreign currency exposure tends to reduce Canadians’ portfolio volatility.

“This happens because the Canadian dollar tends to depreciate relative to the U.S. dollar and other major foreign currencies in times of economic stress,” says Kulesh. The most recent and egregious example was in 2008, he says, when the Canadian dollar depreciated 38% relative to the U.S. dollar, which would have meaningfully reduced the drawdown of a global portfolio in Canadian-dollar terms.

The loonie typically lags other currencies because both it and the Canadian economy are linked to the commodity cycle, says Kulesh.

“In times of economic uncertainty and financial downturns, commodities don’t tend to fare well for obvious reasons, so neither does the Canadian dollar,” he says. Also, the U.S. dollar is the world’s safe-haven currency, where investors flock when they’re worried, he adds.

As further testament to how foreign currency exposure reduces volatility in a Canadian investor’s portfolio, data show that portfolios without a currency hedge experience lower volatility than hedged ones, Kulesh says. The exception is emerging markets, which, like Canadian markets, have been commodity driven.

“This is naturally changing as they’re developing their tech sectors [and] as they’re transitioning to be more service-oriented economies,” he says. As they do so, emerging market currencies will have a similar volatility-dampening effect in Canadians’ portfolios.

The bottom line, says Kulesh, is that “Canadian investors with more mid- and long-term horizons and diversified currency exposures have less need to worry and could even benefit from foreign currency exposures in their portfolio.”

This changes for investors with shorter time horizons, who should speak to their advisors about reducing currency fluctuations, he says.

In such cases, Kulesh recommends employing hedged vehicles rather than avoiding foreign investments altogether.

This article is part of the AdvisorToGo program, powered by CIBC. It was written without input from the sponsor.