To hedge or not to hedge?
That is the question a number of fund managers are fretting over after watching a strong Canadian dollar chew up the returns on U.S. and international funds in recent years.
"It's a frequent subject of discussion at our research meetings," said Don Reed, president and CEO of Toronto's Franklin Templeton Investments Corp.
Currency hedging -- or limiting the risk of holding oversees investments by contracting to sell foreign currency in the future at a predetermined price -- goes against Templeton's investment philosophy of holding equities for five years or longer. The bulk of wealth asset management firms do not hedge in foreign funds, opting to trade equities in local currencies.
Nevertheless, an estimated 15 per cent to 20 per cent of global funds are picking stocks and making some currency bets. Funds managed by AIM Funds Management Inc., Dynamic Mutual Funds, Guardian Group of Funds Ltd. and Mackenzie Financial Services Inc. use some currency hedging tools. Several fund companies interviewed are debating the merits of new products that employ hedging strategies.
And it's no wonder, especially when it comes to U.S. equity funds. The strength of the Canadian economy and a booming resource cycle has had a dramatic impact on the exchange rate. In January, 2002, a U.S. dollar would have cost you $1.61; today, it's about $1.26.
To make matters worse, U.S. markets are struggling. The Standard & Poor's 500 index is up a measly 8.6 per cent in the past 12 months, compared with a gain of 15.3 per cent for Canada's S&P/TSX composite. Canadian large-cap U.S. equity funds have -- on average -- posted negative returns for one, three and five years.
Hedging has been James O'Shaughnessy's secret weapon, however. The New York-based fund manager's well-regarded U.S. equity funds offered by RBC Asset Management Inc. effectively buy and hold U.S. stocks in Canadian dollars.
"We just wanted it to always be a level playing field," he said. "We made the conscious decision [returns] should be delivered to Canadian investors in Canadian dollars and that fluctuations in the currency are sometimes very beneficial."
But don't expect a hedging stampede any time soon. Research indicates that any short-term currency gains are a wash over the long term, several fund executives said.
"If you have an investment horizon of anywhere between three to four years, the cost of hedging does not make up for the benefit that is gained," said Lambros Piscopos, manager at Natcan Investment Management Inc. in Montreal.
And increased hedging costs "really detract from the returns of the portfolio over a long period of time," said Oliver Murray, president and CEO of Brandes Investment Partners & Co. in Toronto.
Bustle in the hedge row
Fund manager James O'Shaughnessy buys U.S. stocks with Canadian dollars.
RBC O'Shaughnessy U.S. Value
TOTAL ASSETS: $562.2-million
MANAGEMENT EXPENSE RATIO: 1.61%
RETURNS, AS OF APRIL 29, 2005
|1-year simple return||12.18%|
|3-year compound annual return||7.23|
|5-year compound annual return||10.86|
TOP 10 HOLDINGS, AS OF APRIL 29, 2005
|7.||Federated Dept. Stores||2.16|
|8.||Bristol Myers Squibb||2.08|
|10.||Pepsi Bottling Group||2.03|
© 2007 The Globe and Mail. All rights reserved.
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