Currency movements can present an element of uncertainty for Canadian investors holding foreign mutual funds or ETFs in their portfolios. The value of currency used to buy or sell the investments may change, which is called currency risk.

 

What is currency risk?

 

Currency risk arises from the change in price of one currency versus another. When investors have assets invested outside of Canada, they face currency risk if their portfolios are not hedged. A declining Canadian dollar versus foreign currencies can add to the returns of mutual funds and ETFs that invest in foreign markets, while a rising Canadian dollar can negatively impact returns on foreign investments.

 

How can currency affect my investments?

 

When the Canadian dollar changes in value against foreign currencies, investors who have unhedged foreign investments are affected. Keep in mind that global and international mutual funds and ETFs are often exposed to more than one currency and not all currencies move in tandem. The same basic principle applies to foreign investments.

 

Currency scenarios:

 

If you were to buy a pair of shoes in the U.S. for $100 and the Canadian dollar moves higher relative to the U.S. dollar over the following months, that same pair of shoes will cost fewer Canadian dollars to buy. By contrast if the Canadian dollar declined relative to the U.S. dollar, then it will cost you more Canadian dollars to buy the pair of shoes.

 

The same is true when investment managers buy foreign securities; they have to change Canadian dollars into the local currency in order to purchase a foreign company’s stock or bonds. When the time comes to sell these investments, the sale is made in the foreign currency and converted back to Canadian dollars. In the meantime, however, the value of the Canadian dollar may have changed in relation to the foreign currency. That transaction can add or detract from your return, depending on whether the Canadian dollar has gone up or down.