It sometimes feels to me that every Canadian I know is a currency speculator. In some ways, we all are. We need US dollars to travel and if you’re like me and the families our firm works with, buying US dollars is an annual transaction. Lately, that trade has been a painful one. Approximately one year ago, the Canadian dollar was worth US$0.92. At the time of this writing it is worth US$0.75, a decline of approximately 18 per cent. The good news? Many portfolio managers, our firm included, have a healthy weighting in US stocks. Therefore, while the US stock market is down in 2015, our exposure has enjoyed double digit gains resulting from the currency. The question now is, “Do we take profits?”
This is what I am talking about: let’s assume a $10 million portfolio consists of a 25 per cent weighting in US equities, all in the SPYDER S&P 500 ETF (SPY), for a position of US$2,500,000. Using 2015 year-to-date returns, the SPY is down about 3 per cent, leaving the US equities valued at US$2,425,000. However, the Canadian dollar has dropped 12 per cent and the US dollar has gained 13 per cent, relative to each other. This means that, in Canadian dollar terms, the US equity position gained about 10 per cent. The initial US$2,500,000 was worth C$2,905,750 at the exchange rate that existed at the beginning of the year. The value today of US$2,425,000 equities is worth C$3,198,810 at today’s exchange rate. That is a great profit.
To help us with the decision of whether to capture the profit by converting some or all of the currency back to Canadian, we looked at the long term cycle of the Canadian dollar relative to the US dollar because at extremes it can be profitable to protect portfolios against an adverse currency move. Consider our portfolio example in the context of the chart below. The chart shows the Canadian dollar value of the US dollar over the 43 years 1972 to 2015. Note that the values in the chart are expressed in terms of how many Canadian dollars it takes to buy a US dollar, so the highest point of 1.6 in 2003 means it cost C$1.60 to buy US$1.00. This is equivalent to a low $0.62 Canadian dollar.
The chart shows that the relative value of the Canadian dollar fluctuates between par or 1.0 ($1.00) on the high side and between 1.4 and 1.6 ($0.65 and $0.70) on the low side. The important thing to note is the long term nature of the trends. The two long downtrends (when the Canadian dollar depreciated) between 1976 and 1986 and between 1992 and 2003 were about 10 years in length. The two main uptrends (Canadian dollar appreciating) were shorter, about 5 years long. It is also worth noting that there are no extended periods of time after 1976 when the dollar was stable. We are currently in the third depreciating trend from the most recent highs, when the Canadian dollar was trading above par with the US dollar in 2011. If history is any guide, it appears that this downtrend will continue for a while longer, but whether the Canadian dollar will eventually reach $0.70 or $0.65 is fodder for cocktail parties. At some point, another long trend will emerge where the Canadian dollar will begin appreciating back to par.
For this reason, we are taking two approaches to crystalizing the gain we have enjoyed over the past four years. The first move is client specific. Most of the families we work with have annual spending in US dollars. In other words, they either live in the US for part of the year or have travel expenses in US dollars. For that reason, we are removing three to four years of costs from the portfolio. If a family has predictable costs of $20,000 USD each year, then we are removing $60,000 USD from the portfolio to fund these expenses for the next few years. This will save the cost of converting back and forth. Should the dollar remain low for an extended period like it has in the past, then our clients will be well covered.
Secondly, from a portfolio strategy perspective we are converting 25 per cent of our US stocks into Canadian dollars. There are currency hedged exchange traded funds that one can buy. This allows us to lock in some of the profits in the currency but maintain our exposure to the US stock market. The current plan is to convert more should the Canadian dollar drop below $0.70.Based on historic trends, as mentioned above, we expect the Canadian dollar to be higher at some point this decade. In the meantime, while your trip south may be more expensive this year, don’t feel too guilty about spending the money. It is likely your overall net worth has increased as a result of the weaker Canadian dollar.
