- 2011: A Global Approach…
- 2010: A Global Approach to Investing
- 2007: Global Investing & Currency Risk
- 2006: International Returns & Currency Movements
- 2005: International Returns & Currency Movements
At Trivest, we take a “global” approach to investing in equity markets as part of a diversification strategy. Over the last few years though, much of the volatility in the values of international investment returns in our portfolios has come from currency fluctuations. When an investor buys an investment in a country, or ‘union of countries’ (as in Europe), he also is implicitly buying the underlying currency. At the end of an investing year, the investor’s return is equal to that foreign market’s return, plus-or-minus the exchange conversion back into the investor’s home currency. In any given year, the cross-currency exchange movements between two countries can be significant.
The following chart shows 2010’s fluctuations:
Year-by-year, cross-currency movements continue to have a significant impact on the net returns to global investors. For instance, those movements between the loonie and the US greenback have been of double-digit proportions in three of the last four years. However, for long-term investors, these large, temporal movements need to be kept in perspective. Of medium-term duration—over the six years 2005-10, the movement of the loonie against both the greenback and the euro has contributed only approx 1% to those two global returns for Canadian investors. Many years ago, the Chinese Communist leader Zhou Enlai was asked about the impact of the French Revolution of 1789 upon the people of Modern Day France, to which his reply was that “it was too early to tell”! The Winter edition of Foresight reviewed the 100 year impact of Canada/US exchange rates (netted of differences in domestic inflation rates). With only one exception (1990-2000), the net impact in any given decade of the 20th Century was almost never more than that same 1%.
The chart below shows the 2010 returns across major economic zones, with currency factored in for global investors:
The shaded returns across the diagonal show the calendar 2010 domestic equity returns in the major economies. All of the other entries include the currency impact to these returns to show the effective returns for investors in those areas who are branching out internationally from their domestic market. The left-most column in the table shows that Canadian investors made their best returns in 2010 through investing in their own market, the ‘TSX 60’. However, the ascent of the commodity-driven Loonie took its toll on the currency-adjusted returns of foreign equity holdings for Canadian investors. Some international ETFs are now “hedged” to remove the currency impact of international investing. Common holdings in our portfolios that do so include “XSP” (the S&P 500), “XIN” (the EAFE Index) and “XSU” (the US Russell 2000 Index).
The following chart shows 2009’s fluctuations:
A sharp run-up in our ‘Loonie’ occurred in 2007, reversed in 2008 and re-reversed in 2009. Canadian investors who invested abroad through 2008 benefited from the depreciation of the Canadian dollar. That situation reversed in 2009 – the foreign currency loss reduced the market recoveries experienced across world equity markets for Canadian investors.
In addition to currency issues, the world’s equity markets themselves have become much more synchronized or ’correlated’. This synchronicity has been augmented with the 2008 financial ‘meltdown’ that affected all the world’s economies — no equity market was left unscathed. Fiscal stimulus and expansion monetary policies were adopted by all countries in a concerted effort to bring back world growth. As a result, global equity market indices increased across the globe.
Correlations are measured and scored numerically between 1.0 (perfectly “in sync”) and minus 1.0 (perfectly out of “sync”). According to a ‘Standard & Poor’s’ March, 2009 calculation, the US equity market (represented by the S&P 500 Index) had a 0.9 correlation over a 60-month time period with the World Index (excluding the US). This represents a high correlation.
The following table summarizes all of this. The shaded returns across the diagonal show the 2009 domestic equity returns in the major economies. All of the other entries add the currency impact to these returns to show the effective returns for investors in those areas who are branching out from their domestic market. The left-most column in the table shows that Canadian investors made their best returns in 2009 through investing in their own market, the ‘TSX 60’. The ascent of the commodity-driven Loonie took its toll on the currency-adjusted returns of foreign equity holdings for Canadian investors. You can see other charts on our website which give longer historical perspective.
Currency-Hedged Exchange Traded Funds
It is becoming easier for an individual Canadian investor to ‘hedge’ against foreign currency movements thanks to a growing number of exchange-traded funds (ETFs) that are designed for Canadian investors and are currency ‘neutral’. For example, a Canadian investor could invest in the S&P 500 Index by way of an ETF, symbol “XSP”, that would have yielded about 26% for 2009 (as above for an American investor) and would not have been penalized for the appreciation of the Canadian dollar (which resulted in a 12% return instead). Other ETFs that have Canadian dollar hedges are the MSCI EAFE Index, the US Russell 2000 Index, and the US High Yield and Corporate Bonds Indices.
2010 Currency-adjusted International Returns
The world of investing usually has a current “hot topic” which is on everybody’s lips on Main Street. For this year, it has been the meteoric rise of the Canadian dollar since March. It is all we can talk about: cross border shopping south of the line takes off, snowbird vacation bookings are up, importers cheer and exporters lay off workers.
Needless to say, the size and speed of the very recent advance of the Canadian dollar against the U.S. dollar has been, historically speaking, unprecedented! Our dollar rose 15% from the beginning of September to a high of 1.09 on November 7th, then fell back to par by November 30th.
As always, it is useful to seek some broader context and perspective. It is nothing new that currency plays a role in transnational investing returns. It is just that, until recently, it hasn’t been us in the limelight!
Here is a chart of the currency movements between Canada, the US, Europe and Japan for the last three years. The “plus/minus” represents the gain/loss of the first named currency at the top of the column, e.g. Canada gained 3.24% on the USD in 2005.
You will see that there have been several double-digit cross-currency movements in the last three years. But Canada’s large swings with the euro in both 2005 and 2006 didn’t gain the attention that the USD did this year because fewer Canadians travel to Europe vs the US, and America is of course a bigger trading partner. Neither did the large currency movements between other regions gain attention in Canada because it wasn’t our problem. Canada in fact was relatively flat with the US in 2005 and 2006.
Investors who spread their money around the globe need to remember that they are investing in both the foreign market and the foreign currency, because they need to buy the foreign currency with which to buy the foreign investment. Canadian investors are encouraged to “cross the 49th” and invest in the world’s global economies. It is commonly cited that Canada only represents approx 3% of the world’s commerce. Furthermore, industry-sector management drives Canadian investors out of Canada because the TSX is heavily over-weighted in resource and finance stocks, and under-represented in other sectors, like health and technology. Lastly, the recent global wave of mergers and acquisitions has hollowed out the TSX, with several large Canadian companies being bought by foreigners.
The following table shows the last three years of international stock market returns in domestic markets, and then adjusts for the currency changes, as per the above table, depending on where the actual investor resides.
The returns (in bold) across the diagonal show the domestic returns in each market index for each of the three years. The other entries in the grid for international investors add (or subtract) the two-country currency movements in the year to that domestic return. So, when an international investor does better than the domestic investor, it means that foreign currency appreciated against the investor’s domestic currency. For example, in 2007, European investors made 4.6% by investing in the Euro 350 Index, but an American investor made 15.4% by investing in the Euro 350 Index, thanks to the 10.8% appreciation of the Euro relative to the U.S. dollar.
As you study any horizontal row’s domestic return and then study the rest of the row, you will see how currency magnifies international investing. As you study any vertical column, you will see how an investor domiciled in a particular country fares through global investing. For instance, the meteoric rise of the Canadian dollar in the last half of 2007 punished Canadian investors who purchased foreign currencies to diversify in foreign markets. For Canadians, the domestic return was 11.4% but the international returns were –6.6%, 1.7% and –10.9%. On the other hand, international investors couldn’t lose investing in Canada over the last three years, thanks to native return of the TSX and/or appreciation of the Canadian dollar.
In conclusion, when you smile or frown about how your international portfolio performed, be sure to understand there are two component parts.
The following tables reveal the 2006 currency movements as well as the index returns for international investors, taking into account those currency movements.
In the first table, the greatest appreciating currency was the Euro against the other major currencies. The Canadian dollar ended up the year by changing very little in value relative to the US dollar.
In the second table, the diagonal (bold) numbers show the domestic returns in each market, eg a European investor earned 19.99% by investing in the Euro 350, the broad-based market index for Europe. As above, the Euro appreciated 11.65% against the Canadian dollar; thus the Canadian investing in the Euro 350 received the domestic Euro return (19.99%) plus the exchange gain when converting back into Canadian dollars (11.65%), totaling 31.64%.
Clearly, the top market winners for 2006 were those who invested in the Euro 350 and converted back to their home currencies. The only negative return indicated was for Europeans who invested in Japanese securities and converted back to Euros.
If economic fundamentals prevail, the future direction for the US dollar is expected to be downwards relative to currencies of countries that the US has trade deficits with. The US trade deficit for 2006 totaled $763.6 billion and reflected a $836.1 billion deficit in goods trade and a $72.5 billion surplus in trade for services, such as banking and insurance, where the United States has a competitive advantage over other countries. The deficit with China shot up 15.4% last year to total $232.5 billion, the largest imbalance ever recorded with any country. The deficit with Canada, America’s largest trading partner, was $72.8 billion, while the deficit with the European Union was $138.5 billion.
The following tables reveal the 2005 currency movements as well as the index returns for international investors, taking into account those currency movements. In the first table, Canada appreciated a bit over the US dollar and both currencies appreciated significantly over the euro and the yen.
The diagonal (bold) numbers in the second table show the domestic returns in each market, e.g. a US investor earned 4.9% in the S&P500. The US dollar depreciated 3.24% against the Canadian dollar; thus, the Canadian investing in the US received the S&P 500 return LESS the exchange loss converting back into Canadian dollars. European and Japanese investors fared very well if they invested in Canada, enjoying both spectacular market returns and currency appreciation. The dual aspects of international investing—market returns and currency—are indeed highlighted.