Responding to currency concerns

By Mark Noble | October 13, 2009 | Last updated on October 13, 2009
4 min read

It might be the single biggest value -add in investment planning you offer clients this year — managing their currency risk. A lot of fund providers have come on board offering currency neutral options on popular global mandates.

Canadian investors and their advisors have been inundated about the need to invest globally. This strategy has been undermined by currency volatility in the U.S. dollar in particular, that has drastically deteriorated international investment denominated in Canadian dollars.

Take last month for example, many of the Morningstar foreign equity fund categories were decimated by currency fluctuations. The Morningstar Emerging Markets Equity Fund IIndex gained 12.3% for the quarter, while eEuropean eEquity and iInternational eEquity were up 12% and 10.5%, respectively. According to Morningstar, the Canadian dollar appreciated significantly against many currencies including the U.K. pound (11.4%), the euro (3.9%), and the Mexican peso (11%).

The Morningstar U.S. Equity Fund IIndex return of, 7% return for the quarter is less than half that posted by the benchmark S&P 500 Index (15.6%) because the loonie gained 8.4% against the U.S. dollar.

There is an argument that currency fluctuations get nullified over time (— eventually value goes to equilibrium). And — aas the last eight years have shown with the Canadian dollar, currencies can have prolonged periods of volatilityy which, which can diminish performance. With a large bulk of fund investors nearing or in retirement, there is a view that they can’t afford to take on high levels of currency risk.

Advisors have articulated this concern , and fund companies like Invesco Trimark and Fidelity have recently launched currency neutral versions of a number of global mandates. Invesco Trimark announced on Tuesday, Oct. 13 it is launching H-series, fully currency hedged versions of many of Invesco Trimark’s global mandates, including the Trimark Fund and Trimark Global Balanced Fund.

John Ciampaglia, senior vice- president of product development at Invesco Trimark says the management fee on the H-series mandates will be the same, with a slight increase of no more than five 5 basis points in operating expenditures, to fully hedge the funds.

Diversifying outside of Canada makes sense., Yyou get access to different sectors, , but the Canadian dollar has been on quite the [multi-year] tear. If you look back to January 2002 the Canadian dollar was trading around 62.5 cents. There is a real currency risk with the Canadian dollar and investors don’t want to give back all their gains on the currency side,” Ciampaglia he says. “The strength of the Canadian dollar, the volatility in the currency markets has been astounding. The option and flexibility of offering H-series makes a lot of sense.”

Ciampaglia , expects the H-series funds to appeal to investors with a shorter- term investment horizon, investors already in retirement, and investors with above-average allocations to global securities. H-series is available on a number of corporate class funds that allow for switching between series and series H on a tax-deferred basis.

In the past, fund companies were hesitant to offering currency hedging since there was a discernable cost associated to it, and many investors experienced a drag in long- term performance.

Ciampaglia points out the universal commitment to lower interest rates around the world, has drastically reduced currency arbitrage opportunities, meaning it’s cheaper for Invesco’s currency trading team in London to implement the currency forward contracts to hedge the portfolios.

“There is not as much difference in the interest rates for most of the world’s major currencies, so selling currency forward contracts has little to no cost,” he says.

Gold: the ultimate hedge?

Investors also have to be cognizant of the growing popularity of gold as a currency. Much of the run-up in gold prices has been the result of demand to diversify into bullion or bullion tracking derivatives to hedge currency risk, says Nick Barisheff, president and CEO of Bullion Management Group.

“Investors are losing confidence in the U.S. dollar as a reserve currency. The U.S. dollar has been the last safe haven currency and with it’s depreciation we see investors moving into gold. We’ve got China and Russia set to increase their reserves to 10%. Barrick Gold, a company that has been bearish on the price of gold for the last two decades, has raised $4 billion dollars to close out their hedging contracts.”

If gold becomes a globally accepted store of value that its proponents are banking on, it could have a massive impact on the price of other currencies, since its physical value currently pales in comparison to the other currency denominated instruments.

Barisheff estimates the current global bullion supply at about $2 trillion , with probably less than half of that available for global trade. In comparison, Barisheff says studies have pegged trade in paper financial assets at around $150 trillion.

“If the world moves to diversify and moves into $1 trillion of privately held gold, with that many net buyers it’s fairly simple math — gold has to go up 15 fold in value,” Barisheff says. “That sounds like a ridiculous number, when someone asks who[AS2] how do you try to value gold, I ask how do you value a dollar?”

Barisheff says the gold price has gone up 27% against the U.S. dollar, 40% against the British pound, 43% in Russian rubles and 22% in rupees, and finally 15% against the loonie. The only currency has gone down in value is the Australian dollar.

Assuming gold’s currency status continues to grow in popularity, Barisheff argues it’s imperative that investors move part of their cash holdings to gold. Barisheff does argue against hedging the price of gold in Canadian dollars, which he says can undermine the pricing gold as a store of value if a manager makes a mistake in executing their hedging contracts. Instead, he advises investors to simply price their purchase of bullion in Canadian dollars.

“We spend our money in Canada, we have to look at the Canadian price of gold, and against the Canadian dollar , gold is up 15% this year.”


Mark Noble