Structured Capital name

Timely Charts

A picture is worth a thousand words ---- except that sometimes pictures can be misleading! In the "Chart Essays" section we present small nuggets of analysis based on charts or "pictures".

Key concept: hedged currency exposure.

Chart Essay #2: January 2009

Foreign Asset Returns for Canadian Investors,

Or, How To Get What You Were Hoping For

In Chart Essay #1 we saw the impact of the Canadian dollar on an investment in US dollar-based commodities. Clearly the same phenomenon will apply to any foreign investment that is not valued in Canadian dollars. Using the same time period, here is what happened to Canadian investments in the S&P 500. Instead of the index itself, we use Net Asset Values (NAV's) of the Barclay's S&P500 I-Shares ETF (US ticker IVV).(1)

Figure 1 shows that from the market low at the end of February 2003, the S&P I-Share rose 99.48% over 56 months to October 31, 2007 for an annualized return of 15.95%. It then fell by -40% from that point to December 31, 2008, still ahead of its starting point in early 2003. 15.95% per year over four and a half years is an amazingly strong return — these are the numbers we saw in the papers every day.

Figure 1

From Chart Essay #1 we can guess the story: a Canadian investor who bought the USD-based IVV did not fair nearly as well. In Figure 2 we add the IVV ETF with NAV's translated into CAD, the red line.


Because of the rising CAD, the investment in I-Shares only rose 26.72% over the 56 months, or 5.21% annualized. Note that in CAD, the investment actually peaked at the end of January 2007, because for the rest of that year the $CN rose faster than the S&P500. From October 2007 to December 2008, the investment in CAD fell -22.5% versus -40% in USD — the fall cushioned by the CAD which was itself falling relative to USD.

There is an alternative for very large and sophisticated investors: they can remove most of the impact of movements of CAD relative to the foreign currency by "hedging" their currency exposure using foreign exchange futures or forwards. Hedging currency exposure has some cost, but (if done properly) it comes close to giving an investor the returns that the foreign investor would get in their home currency, less the costs of hedging. This isn't the place to examine those instruments in detail, but suffice it to say that there are several reasons that forwards and futures are beyond the scope of most retail and small institutional portfolios.

However, there are several important exceptions. One is that Barclay's Canada offers the XSP(TOR) I-Share, the S&P500 Index with currency hedged into CAD. Let's compare the result of investing in the XSP: the pink line in Figure 3.


You can see that the XSP tracks the IVV very closely. Over the March 2003 to Oct 2007 period, a Canadian investor using the hedged XSP gained 93.46% (15.19% annualized) versus the 99.48% gain (15.96% annualized) available to the $US investor — a very close result. Of course the hedged investor also mirrored the larger downdraft of -40.0% in the IVV, with a -43.43% return for the currency-hedged XSP.

The bottom line here is that currency hedging removes the "risk" of currency exposure at a small cost, but has extremely limited availability for smaller investors. If you have a strong belief that your home currency is going to fall relative to the rest of the world, then you might not want to hedge the currency exposure. However, if you thought the Canadian dollar was going to rise, or just didn't know, then you can reduce that risk by hedging at least some of the currency exposure in your portfolio. For example, you could hold a combination of XSP's (hedged) and IVV's (unhedged).

There are several other currency-hedged ETF's, but the most useful in addition to the XSP is the XIN (TOR), which provides an investment in EAFE(2) with currency hedged into CAD. It is important to remember that most money managers, whether offering retail mutual funds or institutional money management, do not offer currency hedging as part of their portfolio structure.


(1) "ETF" stands for "Exchange Traded Fund", investment vehicles that track well-known indexes, and that trade on stock exchanges just like individual stocks. Wherever possible in these chart essays, we will use investment vehicles that small investors actually could have purchased and held. In other places we discuss the benefits of ETF's. (Return to Text)

(2) "EAFE" stands for "Europe, Asia and Far East", and is the most commonly used world-wide (but non-North American) equity index, covering more than 20 country markets. The largest currency exposures in this underlying index are to Yen, Euro, and British pound. The relationship between XIN (hedged to $CN) and EFA (unhedged to $US) will differ from that between XSP and IVV in Figure 3, because the EFA ETF itself has unhedged currency exposure between the $US and the various currencies in the EAFE index. Yes, it's a little complicated!

Structured Capital presents a book by Tim Appelt:

How do you get THERE from HERE?
Learning and Playing the Long-term Investment Game

frontcoverHistorical analysis of long-term global equity and bond returns is used to develop an analytical framework for a historical attribution of returns. In turn this attribution approach is used to develop expectations of future returns that acknowledge the past but take into account current market conditions.

Further information: