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How to master international stock trading with currency hedging
Protect your international stock portfolio from currency fluctuations by hedging your investments.
International stock trading accounts make it easier to access foreign investments and buy into some of the world’s biggest companies like Facebook, Amazon, Google and Apple. However, the Canadian dollar is constantly changing in value, which can eat away at the value of your international investments.
Currency hedging can be used to guard your overseas investments from unfavourable exchange rate fluctuations. Here’s how it works.
How do currency values impact international investments?
When you purchase stocks in a company that’s listed on a Canadian stock exchange, your profit or loss depends on how the company’s stock price changes. If the price goes up 3%, the value of your investment will also go up 3%.
However, when you invest in companies listed on stock exchanges outside Canada—whether by stocks or exchange-traded-funds (ETFs)—your investments will also be impacted by the exchange rate between the Canadian dollar and the currency in which your investments are made.
This type of investment is called “unhedged” because it is not protected against currency movements.
Example: Buying international stocks before the Canadian dollar gets stronger
Say you buy 50 stocks in Company A, which is listed on the New York Stock Exchange (NYSE). Each stock is worth USD$50, so the value of your investment is 50 X $50 = USD$2,500.
Let’s also say that, at the time you bought the stocks, 1 US dollar was worth 1.31 Canadian dollars. You therefore paid $2,500 X 1.31 = CAD$3,275 to buy your stocks.
After a few months, Company A’s stock price rises to USD$60. The value of your investment in US dollars is now 50 X $60 = USD$3,000. You decide to cash in on your investment.
However, the Canadian dollar has gotten stronger over the same period of time. This means that it takes more US dollars to buy 1 Canadian dollar. In fact, every US dollar is now only worth $1.08 Canadian dollars. When you convert your US investments to CAD, you only get $3,000 X 1.08 = CAD$3,240.
This is CAD$35 less than you paid to buy the stocks in the first place. Even though your investments went up in value, you ended up losing $35 just because of the USD/CAD exchange rate. This is what can happen when you buy unhedged international stocks.
What happens if the Canadian dollar gets weaker after I buy international stocks?
Currency fluctuations can actually work in your favour if the Canadian dollar weakens in value compared to the currency in which your investments are held. When that happens, you get more Canadian dollars for every foreign dollar you convert, so your foreign investments will be worth more in Canadian currency.
SummaryPurchasing unhedged stocks and ETFs can be a good thing if the Canadian dollar falls. However, if the Canadian dollar goes up in value relative to foreign currencies, the value of your portfolio would go down. This means you would earn lower returns when converting your foreign profits to Canadian dollars. This is true even if your foreign investments have performed well.
How do I protect international investments from changing currency values?
Investment managers use currency hedging to protect foreign investment portfolios. The object of currency hedging is to reduce the effect that currency changes have on the value of foreign investments. This helps ensure that the only factor affecting returns is changing asset values i.e. stock prices going up or down.
The process is quite complex, but generally investment managers will purchase foreign currency options or do a cross-country swap to protect themselves against unexpected changes in exchange rates. It’s similar to purchasing an insurance policy that protects your investments from foreign exchange risk.
Remember that, while hedging stocks and ETFs can protect you from currency movements, you still won’t earn a profit if the Canadian dollar falls relative to the currency in which your investments are held.
What currency hedging options are there?
International shares can be fully hedged, partially hedged or unhedged:
- Fully hedged – where all of your investments are protected from the effects of currency movements
- Partially hedged – where your investments are partially protected from the effects of currency movements
- Unhedged – where your investments are not protected from the effects of currency movements
To hedge or not to hedge: What should I consider?
The decision on whether to hedge or not to hedge your international investment ultimately comes down to 1 key question: What are you trying to achieve?
If you’re trying to reduce your overall portfolio risk by purchasing short-term investments like international bonds, then you may want to consider currency hedging. Currencies are more volatile than bonds, so fixed-interest securities will benefit from hedging more than variable-interest securities like stocks.
However, if you’re trying to maximize returns, then investing in foreign companies and foreign currency by buying unhedged international stocks and ETFs can be beneficial. This is especially true when the Canadian dollar is falling relative to the US dollar.
While both hedged and unhedged investments come with management fees and indirect costs, currency hedging typically ups your costs. You can expect additional fees of 5-10 basis points if you buy hedged securities. For a hedging strategy to be successful, the benefits must outweigh the costs.
Political and economic factors
Every international investment you make will be affected by regulations, politics and economic state of the country in which those investments are held. You might find it easier to track what’s going on in Canada, but it may be harder to keep up with what’s happening in countries with which you’re not familiar.
Currencies are generally less volatile in countries with relatively stable economies than less-established countries with unstable economies. Currency hedging may be more crucial if you plan to buy investments in an underdeveloped country with a struggling economy.
Pros & cons of hedging
- Opportunity to “lock in” the exchange rate at which you convert international investment earnings to CAD
- Protects international investments against currency movements
- Your portfolio benefits if the Canadian dollar goes up in value relative to the currency in which you’re investments are held
- Potentially more expensive (higher fees for hedged investments)
- Your portfolio won’t benefit if the Canadian dollar goes down in value relative to the currency in which you’re trading
6 key factors that affect exchange rates
An exchange rate is the value of a national currency relative to another currency. Both currencies are referred to as a “currency pair” (i.e. USD/CAD if you’re converted USD to CAD or CAD/USD if you’re converting CAD to USD). The exchange rate between a pair of currencies changes every second due to several factors:
A country with high government debt is less likely to attract foreign investment, which may inflate the national currency. As a result, the national currency may grow weaker in value, which will change the rate at which it can be exchanged for other currencies.
National currencies that are used in economies with a low rate of inflation will generally rise in value. Whereas, national currencies used in economies with a high rate of inflation will generally lower in value.
Foreign investors may avoid politically unstable countries, which can drive down the value of the national currency and weakening the exchange rate. But if a country is politically stable, foreign investors may feel more optimistic about putting their money into the economy, thus driving up the value of the national currency and strengthening the exchange rate.
If the financial institutions that control the national exchange rate decide to increase the rate, lenders will similarly be able to increase the interest rates they charge borrowers. This may attract foreign investors, who see an opportunity to lend money to local businesses for a higher profit.
If the value of a country’s currency is expected to rise, investors will want to buy up more of that currency, so they can sell it when the value goes up and make a profit. This can drive up the value of a currency.
When a country goes through an economic recession, interest rates are likely to fall, which can discourage foreign investment. As a result, the national currency will go down in value relative to other currencies, thereby weakening the exchange rate.
How do I buy international stocks?
You can buy and sell international stocks from Canada by opening a stock trading account with one of the Big 5 Banks or an online broker like Interactive Brokers. These brokers typically allow you to conduct trades 24/7 (subject to the operating hours of the stock exchanges on which you want to trade). Most brokers offer mobile apps that let you conduct trade and check the value of your investments on the go.
Like all types of investing, there are risks involved with trading international stocks that go beyond fluctuating currency values. This includes unpredictable market conditions and complex tax rules that vary between countries.
You can usually apply for an international stock trading account in less than 15 minutes online. You need to be at least the age of majority in the province or territory in which you reside, have a Canadian residential address and valid contact information.
Proof of ID may be required. So make sure you a copy of your driver’s license, Canadian passport and/or Social Security Number (SIN) on hand. You may also need a recent utility bill or bank statement that shows your address, so you can verify that you live in Canada.
Open a stock trading account to buy and sell international stocks
How can I buy ETFs that track international markets?
An international exchange traded fund (ETF) is a simple and affordable to access multiple international stocks in a single trade. An ETF is a collection (or “basket”) of stocks or bonds in multiple companies.
An ETF can contain tens, hundreds or even thousands of stocks and may be designed to mimic the holdings and performance of a particular index. Unlike a managed investment fund such as a mutual fund, ETFs trade like common stocks on stock exchanges like the TSX, NYSE or Nasdaq.
There are a number of ETFs that hold stocks in international companies. Buying units of these ETFs on Canadian stock exchanges is a great way to invest in foreign markets from Canada with and without a currency hedging strategy. Be aware multiple currencies will affect ETFs that track global markets.
|Global or world ETFs (hedged)||Gain exposure to US and foreign markets. Hedged to the Canadian dollar.||iShares Global Monthly Dividend Index ETF (CAD-Hedged) (TSX: CYH). Seeks to replicate the Dow Jones Global Select Dividend Composite Index. Holds securities in over 320 dividend-paying companies from all over the world.|
|Global or world ETFs (unhedged)||Gain exposure to US and foreign markets. Not hedged to the Canadian dollar.||Vanguard Global Value Factor ETF (TSX: VVL). Tracks a wide variety of large-, mid- and small-cap companies in developed markets around the world. Draws on the FTSE Developed All Cap Index and the Russell 3000 Index.|
|Regional ETFs (hedged)||Primarily invest in a specific part of the world like Europe or Asia. Hedged to the Canadian dollar.||Vanguard U.S. Total Market Index ETF (CAD-Hedged) (TSX:VUS). Seeks to replicate the CRSP US Total Market Index, which tracks almost 4,000 large-, medium- and small-cap companies across multiple sectors with an emphasis on large-cap companies.|
|Regional ETFs (unhedged)||Primarily invest in a specific part of the world like Europe or Asia. Not hedged to the Canadian dollar.||Vanguard FTSE Developed ex North America High Dividend Yield Index ETF (TSX: VIDY). Holds stock in companies that provide solid dividends payouts. The majority of holdings are in large-cap companies, which are chosen based on a broad international equity index. The exact index may change.|
|Sector ETFs (hedged)||Invest solely in businesses that operate in a specific industry or sector. Hedged to the Canadian dollar.||BMO Equal Weight Global Base Metals Hedged to CAD Index ETF (TSX: ZMT). Holds investments in base metals companies that are tracked by the Solactive Equal Weight Global Base Metals Index (Canadian Dollar Hedged). All holdings meet minimum market capitalization and liquidity requirements.|
|Sector ETFs (unhedged)||Invest solely in businesses that operate in a specific industry or sector. Not hedged to the Canadian dollar.||iShares Global Agriculture Index ETF (TSX: COW). A medium-risk fund that seeks to replicate the performance of the Manulife Asset Management Global Agriculture Index. Tracks around 35 agricultural companies around the world with an emphasis on US companies. Manages over $265 million in assets.|
In Canada, there are a number of companies that have international hedged and/or unhedged ETFs listed on Canadian stock exchanges including:
- BMO Asset Management
- BlackRock (manages iShares ETFs)
- VanEck Canada
- Hamilton ETFs
- TD Asset Management
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