A rising loonie has let the unhedged version of this top Canadian mutual fund outperform its hedged counterpart so far this year. But owning the currency-hedged version of this mutual equity fund lets Canadian investors profit from ownership of blue chip global technology stocks that simply don’t exist in Canada—without the added worry of currency exchange rate risks.
The performance of U.S. stocks in Canadian-dollar terms has left a lot to be desired so far this year. Even though the more conservative stock market indices south of the border can boast low single-digit gains, these advances turn to losses when translated back to Canadian dollars.
Given that the loonie has appreciated nearly 10 per cent against the U.S. dollar since the beginning of the year, Canadian investors have found that their unhedged U.S. investments have declined by mid-single digits in Canadian-dollar terms over the same time frame. That’s why we’ve been recommending that Canadian investors hedge their U.S. investments against a potential rise in the Canadian dollar for some time now. And given that we continue to feel the Canadian dollar is undervalued, we still feel currency hedging is a good idea when investing south of the border.
The only way a small investor can practically do this is through a currency-neutral equity fund, index fund or exchange-traded fund. Take, for example, Phillips, Hager and North Currency-Hedged U.S. Equity Fund (Series D fund code: RBF1560 (NL)). The fund’s objectives are to provide significant long-term capital growth primarily through exposure to a well-diversified portfolio of quality U.S. common stocks, while minimizing currency risk.
To achieve its objectives, the fund may invest a significant portion, or even all, of its assets in the unhedged version of PH&N U.S. Equity Fund, or other funds managed by RBC Global Asset Management. It then uses derivatives to hedge against fluctuations in the value of the U.S. dollar relative to the Canadian dollar.
Because of its hedging activity, the fund has lost just 1.5 per cent of its value so far this year. This compares quite favorably with its unhedged counterpart, which has declined 9.1 per cent over the same period.
Longer-term results favour the unhedged version of the fund. That’s because, in recent years, the Canadian dollar has fallen against its U.S. counterpart. Over five years, for example, the value of the Canadian dollar has fallen from just over US$1.05 to its recent level of about US$0.79. Over the same time frame, the unhedged version of the PH&N U.S. Equity Fund has a compound annual growth rate of 12.8 per cent, while the hedged version’s return is just 6.7 per cent.
For the time being, though, we prefer the hedged fund, as we feel the loonie is undervalued. If it rises much above US$0.80, however, we would reconsider our advice.
There are benefits in foreign diversification
Though investing in stocks outside of Canada entails currency risk when you don’t hedge your investments, foreign diversification has some offsetting benefits nonetheless. One of these is the opportunity to invest in companies that you either don’t find in this country, or do not find in enough abundance.
Take technology stocks, for example. Less than three per cent of the S&P/TSX Composite Index’s weight is devoted to tech stocks. In the U.S., by contrast, 20 per cent of the S&P 500 Index is made up of these shares.
So when you invest in a fund like PH&N U.S. Equity, you invest in opportunities that are just not available in Canada. The fund, after all, has about 22 per cent of its assets invested in tech stocks. In fact, four of the fund’s largest holdings are global information technology stocks.
The top holding is Microsoft Corp., which accounts for 3.7 per cent of the portfolio. You won’t find a very conservative technology stock like Microsoft in Canada. With a market capitalization of about US$420 billion and cash assets of approximately $128 billion, the company is the largest independent maker of software. You could also say something similar about the fund’s other top tech stock holdings — Alphabet, Apple and Facebook.
Money Reporter, MPL Communications Inc.
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