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McMurtry Investment Report Newsletter
Currency Hedging for Canadians Holding US and International Securities
Peter McMurtry, B.Com, CFA, Financial Writer
October 3, 2016.
Many investors hold individual foreign securities as opposed to owning a mutual fund or ETF. However, by doing this they are exposing themselves to foreign exchange currency risk if these currencies go down relative to the loonie.
Unfortunately, there are few options available currently to address this issue. As a result of their size, pension, mutual and exchange traded funds all have the capability of hedging their foreign currency exposure. The larger the pool of capital available the easier it is to currency hedge and the cheaper it is.
Most retail investors, including high net worth ones, rarely utilize these strategies as they are quite costly and involve leverage or margin and need to be rebalanced periodically. During my many years managing retail monies, this currency risk was rarely addressed even though it commanded a real short term risk.
Over the long term, currency fluctuations tend to even themselves out. Unfortunately, over the short term the clients are most definitely exposed to this additional risk.
I have carefully examined the current strategies available but am not comfortable with many of them. There are forward exchange contracts that involve margin or borrowing. In addition, there are currency options available that normally cost about 1 percent per month.
If an investor simply wants to hedge the currency risk of US cash, there is a Guggenheim ETF with the symbol FXC. The ETF trades in New York in US dollars, but it invests in Canadian dollars only. Consequently, its price movement directly correlates to the Canadian / US dollar exchange rate. When our loonie rises 1 percent against the US greenback, the FXC ETF rises by exactly the same amount and is considered 100 percent correlated.
Suppose an investor has $50,000 US cash sitting in their US trading account. They can purchase $50,000 market value worth of the FXC ETF that will completely shield them from any US dollar devaluation relative to our loonie. If the loonie rises the FXC will rise proportionately and will completely offset any currency decline from the US cash holdings.
Unfortunately using the FXC ETF will only protect investors from their US cash positions. If they also hold individual US stocks or bonds, there will be no more US cash available to purchase additional units of FXC. Thus they remain fully exposed from a currency risk point of view for their stock and bond holdings.
One other hedging strategy is to invest in energy shares. The loonie tends to move dollar for dollar with crude oil prices, both up and down. This is a relatively simple strategy that does not involve using derivatives in any way.
If you believe that crude oil prices will continue to rise with a corresponding rise in the loonie, you can hedge your US dollar stock exposure by buying Guggenheim’s FXC – trading in US dollars.
Alternatively, if you think that crude prices will resume their downtrend, you really do not need to hedge your US dollar stock investments. However, you can currency speculate by purchasing the DLR – US ETF that settles in US dollars and will benefit from a declining loonie and a rising greenback.
Both the FXC and the DLR are US ETF’s that consist only of Canadian and US dollars respectively. They do not own any stocks. There is a time and place to own both of these ETF’s.
What else is available at the moment to address these foreign currency risks?
Most Canadian ETF’s and mutual funds that invest in the US and internationally, offer hedged foreign currency exposure in either a market index format or through specific equity sector ETF’s. The latter offer a much closer approximation to individual stock returns, although they will never replicate the unique characteristics of individual holdings. Due to their large size, they can offer 100 percent foreign currency hedging at a fairly low cost relative to what an individual investor would have to pay.
In addition, owing Canadian ETF’s and mutual funds that invest in US securities makes them more attractive than individual US securities from an estate planning point of view. These ETF’s and mutual funds are deemed Canadian, not US, and are never added to an investor’s US holdings in the calculation of US estate taxes. These taxes can be very onerous and owning both US real estate and US individual stocks and bonds may eventually lead to some US estate taxes to pay upon the estate. On the other hand, owning these Canadian ETF’s and funds will never result in US estate taxes becoming part of the equation, and that differs from owning individual US stocks and bonds. However, to complicate matters, the Guggenheim’s FXC ETF is considered US and would be part of the calculation of US assets from an estate tax point of view.
In conclusion, there is no simple solution available to minimize or eliminate foreign currency exposure for Canadians owing individual US and foreign individual stocks and bonds.
You can use Canadian ETF’s and mutual funds that own foreign securities that hedge out their entire foreign currency risk. These ETF’s also eliminate any potential US estate taxes payable.
You can purchase Guggenheim’s FXC ETF to hedge your US cash exposure.
In addition, you can purchase energy stocks that correlate well with a rising loonie.
Alternatively, you can continue to invest in US and foreign individual securities for the unique growth and income opportunities that they present. But you must always factor in the currency risk in assessing every security. As long as you do this, you will not be disappointed.
McMurtry Invest Report October 2016 Portfolios, Sector Weights and Asset Mixes.
McMurtry Investment Report – Portfolios (October 2016)
| Income | Growth | |||
| Cash | EQ Bank – High Interest Savings (2.0% current rate) | EQ Bank – High Interest Savings (2.0% current rate) | ||
| Bonds | iShares XSB Short Term | iShares XSB Short Term | ||
| iShares XFR Floating Rate | iShares XFR Floating Rate | |||
| iShares CBO 1-5 Ladder Corp | iShares CBO 1-5 Ladder Corp | |||
| iShares CLF 1-5 Ladder Gov’t | iShares CLF 1-5 Ladder Gov’t | |||
| Stocks | Security | Dividend Yield | Security | Dividend Yield |
| Financials | Royal Bank RY | 4.09% | Royal Bank RY | 4.09% |
| TD Bank TD | 3.78% | TD Bank TD | 3.78% | |
| Sun Life SLF | 3.79% | Element EFN | 0.61% | |
| Firm Capital FC | 6.75% | Visa V US | 0.68% | |
| JP Morgan JPM US | 2.88% | JP Morgan JPM US | 2.88% | |
| Energy | Freehold FRU | 3.79% | Freehold FRU | 3.79% |
| Whitecap WCP | 2.55% | Whitecap WCP | 2.55% | |
| Inter Pipeline IPL | 5.63% | |||
| Materials | Agnico Eagle AEM | 0.74% | Goldcorp G | 0.49% |
| Roxgold ROG.V | ||||
| Industrials | WSP Global WSP | 3.63% | WSP Global WSP | 3.63% |
| Magna MG | 2.30% | Magna MG | 2.30% | |
| ZCL Composites ZCL | 2.88% | |||
| Consumer Discretionary | Home Depot HD US | 2.14% | Home Depot HD US | 2.14% |
| Time Warner TWX US | 2.02% | Time Warner TWX US | 2.02% | |
| Pepsico PEP US | 2.77% | Pepsico PEP US | 2.77% | |
| Telecom | BCE BCE | 4.51% | BCE BCE | 4.51% |
| Telus T | 4.25% | Verizon VZ US | 4.44% | |
| Consumer Staples | Alimentation Couche Tard ATD.b | 0.49% | Alimentation Couche Tard ATD.b | 0.49% |
| Mondelez MDLZ US | 1.73% | |||
| Technology | Apple AAPL US | 2.02% | Apple AAPL US | 2.02% |
| Cisco CSCO US | 3.28% | Shopify SH | ||
| Facebook FB US | ||||
| CGI GIB.a | ||||
| Alphabet GOOGL US | ||||
| Utilities | Fortis FTS | 3.79% | Fortis FTS | 3.79% |
| Emera EMA | 4.42% | Emera EMA | 4.42% | |
| Healthcare | CVS CVS US | 1.91% | IBB ETF IBB US | 0.15% |
| Zimmer Biomet ZBH US | 0.74% | |||
| Real Estate | Cdn Apt. REIT CAR.un | 4.08% | Cdn. Apt. REIT CAR.un | 4.08% |
| Chartwell REIT CSH.un | 3.56% | Chartwell REIT CSH.un | 3.56% | |
Explanation of Changes to the October 2016 McMurtry Investment Report Portfolios
There are now eleven equity sector groups with the addition of Real Estate.
The financial sector weight was reduced by slightly over 3% with the switch of the Canadian and US Reits to this new sector. Both Canadian Apartment and Chartwell Reits were affected by this change.
In the Growth portfolio I removed Tahoe Resources as they are still in the process of digesting the acquisition of Lakeshore Gold and the share dilution that has resulted remains a major issue.
Roxgold is a better small cap gold play with their ore deposit having very high grade and low operating costs.
In the healthcare sector, I am removing Allergan and recommending that investors wanting biotech exposure are better off switching to the IBB biotech US ETF. This ETF significantly reduces any company specific risk, but still provides good exposure.
In the consumer discretionary area, I am switching out of Starbucks into Pepsico. Pepsi has much better earnings visibility with their ongoing $1 billion productivity campaign to reduce costs and improve operating margins. Their recent quarterly earnings report was better than expected. I am including Pepsi in both the Income and Growth portfolios with its solid 2.77% dividend.
In regards to sector weights, I remain overweight in Financials, Industrials, Consumer Discretionary, and Technology and underweight in Materials, Energy, Telecom, Consumer Staples, Utilities and Healthcare.
I am market weight the new Real Estate sector.
There are no changes to the recommended asset mix.
McMurtry Investment Report – Sector Weights (October 2016)
| Equity Sector Weights (%) | ||||
| Sector | My Weight | TSX Comp | S&P 500 | 50/50 |
| Financials | 24.25 | 33.10 | 12.80 | 22.95 |
| Energy | 12.50 | 20.70 | 7.30 | 14.00 |
| Materials | 6.30 | 13.10 | 2.90 | 8.00 |
| Industrials | 11.25 | 8.80 | 9.70 | 9.25 |
| Consumer Disc. | 13.00 | 5.20 | 12.50 | 8.85 |
| Telecom | 2.00 | 5.30 | 2.60 | 3.95 |
| Consumer Staples | 5.50 | 4.10 | 9.90 | 7.00 |
| Technology | 14.25 | 2.90 | 21.20 | 12.05 |
| Utilities | 2.00 | 2.70 | 3.30 | 3.00 |
| Real Estate | 3.15 | 3.20 | 3.10 | 3.15 |
| Healthcare | 5.80 | 0.80 | 14.70 | 7.75 |
| Totals | 100.00 | 99.90 | 100.00 | 99.95 |
McMurtry Investment Report – Asset Mix (October 2016)
| Asset Mix – Income and Growth Portfolios | ||
| % | Income | Growth |
| Cash | 25 | 15 |
| Bonds | 15 | 10 |
| Equities | 60 | 75 |
| CDN | 30 | 37.5 |
| US | 30 | 37.5 |
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