Currency-hedged Funds

Date: Friday, May 12, 2006
Author: Gordon Pape, Fundlibrary.com

It may be a case of locking the barn door after the horse has gone, but some companies are introducing funds that allow Canadians to invest in American stocks without exposing themselves to a further slide in the value of the U.S. dollar.

The strength of the loonie since the beginning of 2003 has been the main reason why most Canadians have not fully benefited from the bull market on Wall Street. According to Globeinvestor.com, the S&P 500 gained almost 50% over the three years to April 6. But the average U.S. equity fund added less than half that. The rest of the profits were eaten up by currency losses.

A few funds managed to avoid this by using currency hedges, such as the two RBC O’Shaughnessy U.S. funds. But most did not, and investors suffered accordingly. Now some companies are trying a different approach by setting up parallel funds. One retains full U.S. dollar exposure while the other is hedged back into Canadian dollars.

It is important to understand that this is completely different from simply offering U.S. and Canadian dollar units of the same fund, which many companies already do. There is a widespread impression that this is a way to beat the currency problem. It is not – the underlying valuation is the same for both types of units.

To my knowledge, the first major company to offer a parallel U.S. fund was Dynamic. It introduced the Dynamic Power American Currency Neutral Fund in July 2005, which is simply the Dynamic Power American Growth Fund with the exchange rate risk removed. So far it hasn’t worked out that well; over the six months to March 31 the Currency Neutral Fund had a gain of 14.6% in Canadian dollar terms while the original American Growth Fund was ahead 17.6%. However, it should be noted that the comparative results have been swinging back and forth so it’s still too soon to say how this will work out over the longer term.

Now Mackenzie Financial is going down the same road. The company announced in March that it has created currency hedged versions of two of its funds, Mackenzie Universal American Growth Capital Class and Mackenzie U.S. Growth Leaders Capital Class.

Commented Mackenzie president David Feather: "These new currency-hedged funds give investors greater choice and the ability to participate in the growth of U.S. equity markets while maintaining control over their exposure to the U.S. dollar."

Investors will have the option of investing in two classes of units – the new hedged version and original unhedged version. Each class will be identifiable by its name; e.g. Mackenzie Universal American Growth Capital Class will be comprised of Mackenzie Universal American Growth Capital Class (Hedged Class) and Mackenzie Universal American Growth Capital Class (Unhedged Class). You’ll be able to switch back and forth between the classes without triggering a taxable event.

I’m concerned about what seems to be a growing trend in the industry for a couple of reasons. First, it comes very late – more than three years after the loonie started its rise. If the fund companies had acted back in late 2003 or early 2004, they could have enhanced investor profits considerably. Although our dollar may continue to rise going forward (which is by no means a certainty), the gains will not be anywhere near the magnitude we have seen to date.

Second, these new options in effect invite investors to become currency traders. Think the loonie is going higher? Buy the hedged version. Think it’s going to drop? Switch to the unhedged version. How many people are in a position to make such calls?

Finally, more options further complicate the choices facing investors, who are already struggling to make sense out of the alphabet soup of fund units. According to my calculations, there are now 10 different ways to buy Mackenzie U.S. Growth Leaders, including the various purchase options. Someone should sell programs!