Even if you hold 100% of Canadian equities, aren't you still greatly exposed to currency risk indirectly?

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Felr3
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Even if you hold 100% of Canadian equities, aren't you still greatly exposed to currency risk indirectly?

Post by Felr3 »

So it seems like the common saying is "If you want less currency risk, invest less in foreign equities". And that's why we have a lot of people allocating almost half or more of their portfolio in the Canadian market.

But let's say that you had 100% in Canadian equities. You would think that you took currency risk out of the equation completely.

When it's time for you to retire, the Canadian dollar appreciates. Great!Most Canadian investors will be glad that they didn't have a lot invested in foreign currencies. This is the reasoning behind the high Canadian equity allocation in many Canadian investors' portfolios.

BUT let's say the Canadian dollar depreciates.

If you had a lot of holdings in foreign currencies, the depreciation will work in your favour. But this is not the point here. We know that currency risk can work for or against you.

My question is this: If you had all of your equities in CAD, wouldn't you be heavily affected by this currency swing?

Although you aren't directly experiencing the effect of depreciation because you are not converting USD investments into CAD cash, almost all the things you buy in Canada are imported. Even if your Canadian investments didn't move in value on paper, your purchasing power would become weaker as the price of most goods in Canada would increase. No?

So in fact, avoiding foreign investments completely is actually a bad thing when it comes to managing currency risk?

So what's the optimal ratio? Wouldn't you want half of your assets in Canadian dollars and the other half in foreign currencies to balance out this risk? And since your housing price, income and fixed income goods are going to be in CAD, it's better to go much lower in your Canadian equity allocation to actually AVOID currency risk? Like 10 to 20%?

Currently, people think that holding 50% or higher in Canadian equities is a good way to manage exposure to currency risk. But isn't that actually false if what I am saying is true?!
twa2w
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Re: Even if you hold 100% of Canadian equities, aren't you still greatly exposed to currency risk indirectly?

Post by twa2w »

But how much hidden currency risk do you have. And how do you hedge it.
Canadian companies often have operations in other countries ( even Cdn banks).
Canadian companies with all operations in Canada often have to buy raw materials outside Canada or sell product outside Canada.
Many goods and services you buy are produced and sourced in other countries.
When you travel out of country or snowbird. Etc etc
All of these give you currency exposure to potentially many currencies. How do you figure out how much exposure is right.
Maybe 100% Cdn allocation is enough exposure to currency? but perhaps too narrow in terms of investment diversification.

Is your currency risk for cost of living expenses different than your investment currency risk.
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Re: Even if you hold 100% of Canadian equities, aren't you still greatly exposed to currency risk indirectly?

Post by gobsmack »

Felr3 wrote:So it seems like the common saying is "If you want less currency risk, invest less in foreign equities". And that's why we have a lot of people allocating almost half or more of their portfolio in the Canadian market.
In the case of bonds, it makes sense to only invest in the Canadian market. The gains are likely to be small and, if you were investing abroad, currency fluctuations would end up dictating most of your returns. When it comes to equities though, I think the preferential tax treatment of the dividends is probably the main reason why people end up holding more Canadian equities.
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Re: Even if you hold 100% of Canadian equities, aren't you still greatly exposed to currency risk indirectly?

Post by Houska »

Felr, I think you raise an important point (good 1st post!)

It's long been my contention that many investors are *too* Canadian centric in their investments since they underestimate how much of their eventual cash needs --- for which they are investing -- will functionally track the USD more than the CAD.

Roughly speaking, financial expenses (interest, property taxes, etc) and energy costs are truly denominated in CAD. Many discretionary expenses, such as travel, consumer electronics, luxury goods, etc. actually track the USD. Food, etc. are a blend of the two. What that means is that a hypothetical retiree who will melt down their portfolio (RRSP, RRIF, whatever) for basic living expenses will have primarily CAD-denominated needs and so should try to limit their non-CAD exposure. A hypothetical retiree who say has a defined benefit pension plan that will cover the basics and is investing to have a nest egg for discretionary spending should, all other things being equal, probably invest less in CAD than they typically do.

Doing the calcs exactly right is challenging since you would have to add the bottom up USD, CAD, and other exposure for both your needs and for individual sectors in the economy. So this is a general rule of thumb. In particular, I think most people who invest in vehicles that deliberately hedge non-CAD investments to CAD are making a mistake, for this and other reasons.
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Re: Even if you hold 100% of Canadian equities, aren't you still greatly exposed to currency risk indirectly?

Post by Peculiar_Investor »

Welcome to the OP.

Our wiki contains an article about home country bias that might interest you. In particular I would draw your attention to a couple of Vanguard Canada papers that are referenced in the wiki: After reading the Vanguard papers I've come to a better understand of my biases and what other factors to consider, including but limited to currency risk. This was helpful to me when reviewing my Investment Policy Statement and setting our asset allocation.

I would invite the OP to read these papers. Do they change your thinking?
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Re: Even if you hold 100% of Canadian equities, aren't you still greatly exposed to currency risk indirectly?

Post by ghariton »

In addition to finiki, there have been a couple of threads here. On them, I took what seemed to be a minority view, that currency diversification is important, and that one of the problems with being wholly invested in Canadian securities and other assets is the lack of currency diversification.

Diversification is diversification. When it comes time when we need the money from our investments, we sell as much as we need and use money. So I can hold pipelines even though I don't plan on ever eating a pipeline. Holding the pipeline does help me eat what hamburger (and who knows? filet mignon) when it comes time to eat. IOW there is a limit to how much matching I want to do between my investment now and my consumption in retirement. Slavishly over-matching will defeat the diversification that really matters, i.e. risk reduction.

So with currencies. To me it seems madness to rely wholly on a currency that is highly dependent on world prices of commodities and especially oil and gas. That is especially true of a smallish open economy that is heavily dependent on trade. All you have to do is look at the gyrations of the CAD versus a basket of currencies -- or even just the USD -- over the past several decades.

As a secondary thought, import prices do ripple through our economy. I no longer have access to the relevant input/output tables, but the impact is much larger that intuition would suggest. A lot of machinery, plant and equipment used by our industry (or what's left of it) is imported. These costs are passed on. Natural resources -- do we make our own drilling rigs, or do we lease them from elsewhere? Same with mining equipment. Certainly true of telecommunications equipment.

When we want to hire top-notch people, very often we are competing with other countries, and in particular the U.S. Do you think that compensation does not show up in costs of the products -- and do you not think that it drags up the compensation for others as well?

And on, and on.

FWIW my portfolio is one third fixed income, held in Canadian-denominated bonds, and two thirds equities, held in USD denominated unhedged ETFs. That sure helped smoothe out the 2015-2016 roller-coaster.

YMMV, obviously

George
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Re: Even if you hold 100% of Canadian equities, aren't you still greatly exposed to currency risk indirectly?

Post by MortgageSlayer »

Peculiar_Investor wrote:Welcome to the OP.

Our wiki contains an article about home country bias that might interest you. In particular I would draw your attention to a couple of Vanguard Canada papers that are referenced in the wiki: After reading the Vanguard papers I've come to a better understand of my biases and what other factors to consider, including but limited to currency risk. This was helpful to me when reviewing my Investment Policy Statement and setting our asset allocation.

I would invite the OP to read these papers. Do they change your thinking?
To be honest, after reading these papers on home country bias, I am even less inclined to holding CAD dominated assets. I'll be investing in VTI + VXUS + Canadian bonds (only CAD component) based on these findings.
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Re: Even if you hold 100% of Canadian equities, aren't you still greatly exposed to currency risk indirectly?

Post by 8Toretirement »

Currency risk for Canadian investors is the conversion cost between the home currency and the investment currency. What you are describing is inflation wrapped within the business cost of goods that is passed onto the consumer.

Investing in international stocks provides diversification, international currency differences with the home country are part of the diversification process.
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Re: Even if you hold 100% of Canadian equities, aren't you still greatly exposed to currency risk indirectly?

Post by kcowan »

I have a little US and Other. But I have found that the C$ has gained 33% against the M Peso in the last year.
It has also increase slightly against the Euro. So the US holdings have really been an welcome bonanza in speculative holdings and a hedge against inflation. We spend no time in the US otherwise we might increase our US holdings.
For the fun of it...Keith
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