We All Have Foreign Currency Risk. Do You Know What Yours Is?

As Canadians, we are all aware of how the value of the US Dollar can impact a winter vacation south of the border. But are you aware of the foreign currency exposure in your portfolio? Since the elimination of the foreign content rules in our RRSPs, Canadians have...
 moved to greater diversification in their investments, not only to the capital markets in the USA, but also to markets in Europe, Brazil, China, India and beyond. When you buy a stock, bond, Treasury bill or mutual fund outside Canada, you are buying an asset in a foreign currency. Not only are you exposed to stock or bond price fluctuations, but you are exposed to currency fluctuations. Do you need to become a “currency trader”? As with all assets in your portfolio, you should understand the exposure you have to risk and make an informed decision as to the level of risk you are willing to accept.

Let’s take a look at what happened in three markets last year and then what risk exposure you may have beyond those markets. In 2009 the TSX Composite rose about 34% and the Standard and Poor 500 in New York rose about 26%. The Canadian dollar rose from 81.53 cents US to 94.90 cents US or about 17% according to Bank of Canada statistics. For Canadians who held US dollar stocks, they had a good return in 2009 in US dollars. However, on a Canadian dollar basis the loss of 17% on the currency made the US returns look tiny in comparison to the TSX returns. Conversely, an American investor who owned Canadian stocks would have received an eye popping return of over 50% in US dollars! Since most Canadians’ expenditures are in Canadian dollars, you should be aware of how currency fluctuations can increase or decrease the value of your portfolio.

Are you an investor in Europe or the developing countries? Do you know what risk exposure you have to the markets in China, Brazil or India? All currency prices fluctuate just as stock prices do. However, some currencies are “pegged”, while others are not. As with stocks, there is a good time to buy and a good time to sell. Be aware of this other variable.

When you see international headlines concerning the finances of a country, take note. For example, Portugal, Ireland, Italy, Greece and Spain (the PIIGS) have grabbed international attention due to their large budgetary deficits. Each of them is part of the “Euro Zone”. Could their difficulties affect the value of the euro in relation to the Canadian dollar? Yes they could. However, because the economies and financial accounts of Germany, France and others are in better shape than the PIIGS, those economies will help to maintain the euro’s value. Continue to watch as the government of Greece in particular, tries to resolve its budgetary problems and how the people of Greece respond.