by Scott Ronalds

When investing in foreign stocks, currency swings can play a big role in short-term returns. The last two months provide a great example of this, as the Canadian dollar has surged. Several currencies have lost considerable ground against the loonie, including the U.S. dollar (-8%), Japanese Yen (-7%) and Swiss Franc (-7%). The British Pound is down 5% and the Euro down 3%.

All other things being equal, stocks held in these currencies are now worth less in Canadian dollar terms. In other words, their short-term returns in Canadian dollars are lower than their ‘local currency’ returns. Foreign stock prices have been relatively stable over the past two months, but because of the currency impact, the returns of foreign funds for Canadian investors have been weak.

This is a concept that’s easier to grasp with a real-world example. Consider Ecolab, an American stock held in our Equity Fund (the company develops products and solutions for clean water and safe food).

  • On May 31, the stock’s U.S. price was $132.84. We held 40,400 shares, for a value of U.S. $5,366,736. When converted to Canadian dollars – at an exchange rate of $1.35 at the time ($0.74 CAD/USD) – our investment was worth $7,250,460.
  • Fast forward to July 31: the stock closed at $131.67 (little changed from its price two months earlier) for a value of U.S. $5,319,468. The U.S. dollar depreciated 8% over this period though, to close at $1.25 ($0.80 CAD/USD). Our investment, in turn, was worth $6,654,650 in Canadian dollars.
  • While the stock declined less than 1% in U.S. dollars over the period, the value of our holding in Ecolab in Canadian dollar terms was down 8%.

Of course, when the loonie is falling against other currencies, investors benefit from the opposite effect: foreign stocks are worth more in Canadian dollar terms.

The recent strength in our dollar has had the biggest impact on our Global Equity Fund (100% foreign stocks), but our Equity Fund (45% foreign), Small-Cap Fund (8% foreign) and Founders Fund (29% foreign) have also been impacted.

Over the longer term, the impact of currency movements tends to be less dramatic, and holding stocks valued in different currencies provides a portfolio with an additional source of diversification. This is why our managers rarely hedge the currency exposure in our funds.