Monday, July 20, 2009 8 comments ++[ CLICK TO COMMENT ]++

One should always have a strategy regarding the currency

Veteran investors already do this by default but if you are starting out in investing, you should give some thought to currency fluctuations. This is especially important if you are investing in foreign lands. Changes in the currency alone can be as much as your actual stock return.

Even if you don't invest overseas, it matters what happens to your local currency. For instance, let's say the inflationists are right and the US$ declines precipitously over the next few years. Well, even you don't feel it, your portfolio may actually be losing its purchasing power.

The following chart shows the Dow Jones Global Stock Market index in US$ (this is the official index) and the index in Canadian dollars. This index is obscure but I use this as my main one because it is the broadest one that covers the world (for simplicity, many use S&P 500, especially if they mostly invest in the US markets.)



As you can see from the chart, at one point in 2007, there was a big difference between the two lines. The gap is a massive 30% (roughly). Think about how big that is. In the long run, the stock market returns 10% per year. So you are looking at 3 years worth of returns simply due to currency fluctuations. I had problems with my portfolio back in 2007 because most of my holdings are in US$-denominated assets. Long-time readers may recall how I posted a loss in 2007 due to the US$ decline (I measure my portfolio in C$).

By the end of 2008, the gap had closed and it was almost as if the currency did not matter. The fx gain boosted my return last year by around 18%. That's one reason I am not happy with my performance last year. My portfolio did far worse than it seems (also, unlike many value investors, I have permanent impairments whereas some only have quotational losses.)

Lately, with the rally in the markets and the return of the re-flation trade, a new gap is forming. There is a possibility that my portfolio will suffer a 5% to 10% loss due to the US$ declining; but I lean towards deflation so I'm not entirely sold on this.


There are two strategies to follow with the currency. Macro investors almost always try to predict the currency and try to position themselves against any adverse changes. However, like trying to predict any future economic trend, a wrong bet can lead to losses. You just need to look at all those who were certain that the US$ was going to plummet and invested heavily in emerging market and commodity currencies over the last few years (think about macro-oriented investors like Jim Rogers.) Well, we all know how that ended. They lost as much as 20% on the currency alone.

The other strategy is to sort of ignore the currency and simply buy companies that can beat currency fluctuations (if you are thinking of foreign stocks) or inflation (if you are thinking of local stocks.) This is the strategy pursued by most value investors. Ideally the companies you own will be able to maintain profitability or their asset values. But, contrary to thinking of some, there are very few true inflation hedges. My opinion is that, what many perceive as companies with pricing power may turn out not to have any during inflation. However, this approach is probably better for most investors. It's probably easier to try to find a company that may be able to maintain its asset values or earnings, than trying to predict currency moves.


As for me, I do not hedge my portfolio. I do factor in my macro opinion—for instance I have been bullish on the US$ for the last 3 or 4 years, with admittedly dubious results—but I do not expect the C$ to be move drastically away from the US$ (even if it did, I would expect it to revert to the original value in 10 or 20 years; however this won't be the case against developing countries, whether you are looking at China or South Africa or whatever.)

I also try to have brokerage accounts in foreign currencies. This way, I do all the buying and selling within the account and I don't end up converting back and forth across currencies. Not only do you avoid commissions on conversions, but you also avoid inadvertetly converting at the wrong time and suffering losses. For instance, imagine if a Canadian sold off some US stocks in early 2008 (it was near the peak after all), when the gap was large in the chart above, and converted to C$. Well, if you were waiting for an investment opportunity until late last year (the market was collapsing until then), you would have suffered a loss of as much as 20% (relative to someone who stuck with the US$.) Then if the gap widens and you sell, say today, you would probably take another 5% loss (assuming the C$ comes back to what it was when you purchased it). Depending on how you track your finances, you may not even realize all the losses due to the currency.

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8 Response to One should always have a strategy regarding the currency

Daniel M. Ryan
July 21, 2009 at 2:16 AM

The lot of a Canadian trading in U.S. stocks, I suggest. The trouble for we Canadians is that there's a lot more observation and study of the U.S market and its vagaries than ours. So, it's more straightforward to value invest in U.S stocks than to try it with Canadian issues.

Canada never had a Ben Graham.

Sivaram Velauthapillai
July 21, 2009 at 10:24 AM

Yeah... for me, the big thing is that the Canadian markets are not diversified. Essentially it is made up of natural resource companies and financial companies (unfortunately this is a bad thing for the country.) In the late 90's, there were some technology companies but there were only a few leading ones. I turned bearish on commodities a few years ago and was bearish on financials too (not because I expected a financial crisis but because the Canadian banks were the top performing developed country banks, in stock returns, for the last 10 or 15 years, at that time.)

I think pure value investors can probably generate higher returns in Canada. There is less competition and less easily available information. For instance, there is nothing like the elaborate system of reporting that is required by the SEC--even if the reporting is there, it is not easily accessible online or through searching systems. If someone went on the SEDAR website (this is the equivalent of the SEC site), the documents are hard to filter; not easy to search; etc. We also don't have as many financial publications like the US. We don't have anything like Barron's or Investor's Business Daily; obviously we don't have magazines like Fortune, BusinessWeek, etc covering as many businesses; and so on.

So an American, or some other foreigner, who is bottoms-up should probably see if they can perform better in Canada.

hpmst3
July 21, 2009 at 8:47 PM

Sivaram,

What brokers do you use for each currency these days?

hpm

hpmst3
July 21, 2009 at 9:29 PM

I have been looking for an internet broker for Hong Kong/Chinese companies.  

Have you looked into possible brokers for those currencies?

FYI, I deleted my last question, because I felt that an answer could raise privacy issues for you. Sorry for the mixup Sivaram. :)

hpm

Sivaram Velauthapillai
July 21, 2009 at 9:42 PM

Do keep in mind that this is just a suggestion and it may not be appropriate for all. For instance, if you typically buy a stock and hold them for 10 to 15 years--I have run across many on message boards who have owned companies like ExxonMobil or Gillette/P&G for a decade--then multiple currency accounts may not be that important (it is probably still helpful if you receive a lot of dividends and re-invest them). If you own mutual funds and continuously add to them for years, without withdrawing/selling any, then it may not be worth having a seperate currency account.

Anyway, I live in Canada and I'm not sure where you are, but the idea is similar.

If you are in Canada, almost any broker can set up an account in US$. Since Canadians are likely to invest heavily in US stocks over their life, I suggest that you open up a US$-denominated account in addition to your C$ one. I simply transfer some money into the US$ account and basically leave them there forever (and use that money to buy stocks on US exchanges). By default I also have a C$ account that I use for mostly buying on Canadian exchanges (or in some cases US ones.)

Beyond that, it depends on what your outlook for hte future is, and where you plan to invest--not just once but many times. For the time being, I have a Yen account. I was bullish on Japan a few years ago and thought of open up Yen account. I used it to buy a Japanese stock, directly on the Tokyo Stock Exchange. THe pick was a disaster but hopefully future ones won't be.

Finally, to answer you question, I think you should not use my brokers blindly. You should research and see what is the cheapest for you. What is cheap for you may not be cheap for me. For instance, some offer very low commissions if you have something like $100,000 or $200,000 or whatever; whereas others may offer low commissions if you have many transactions; if you actually read analyst reports, some offer better reports than others. If you invest in mutual funds then some brokers may be better than others. And so on.

Sivaram Velauthapillai
July 21, 2009 at 9:42 PM

Anyway, my two brokers are CIBC, which is my main banking account too, and HSBC. CIBC is basically C$ and US$; while HSBC is C$ and Yen. HSBC's commissions are expensive (unless you have over $150k(??) I think, which I don't) but I went with it because it is more international and offers easier trading on foreign exchanges (almost any brokerage allows you to buy on overseas exchanges but HSBC seems cheaper and easier). I also picked HSBC because they had better, free, analyst reports. But they changed their analyst reports (used to be Merrill Lynch, which is really good, but is now just HSBC and Morningstar) and I don't read analyst reports like I used to. Although value investors diss Wall Street and Bay Street analysts, their in-depth reports, if available freely, are good for newbies like me. They introduce you to a particular industry.

If you are starting out...if you like your banking institution... and commissions/fees/etc are low, I would probably stick with the bank's discount brokerage as your primary one. In Canada, there are only a few banks and you really don't have much choice between them (in USA, it may be different since you have more choices). Sticking with the same bank means that it is easier to transfer money and so on.

(If you are a trader, there are brokerages that are supposedly much better given your volume of transactions. Companies like Interactive Brokers allows you to trade almost anywhere in the world and seem suited for high transaction investors.)

Sivaram Velauthapillai
July 22, 2009 at 10:54 AM

I'm pretty open so I'm cool with disclosing my stuff (others may want to be more careful though). Some guy intercepting my physical mail delivery will know more than anything I disclose on the Internet...

If you are in Canada, see if HSBC is cheap enough for you. You can buy directly on the Hong Kong exchange without going through a (phone) broker. I have never done it but they seem to be set up for HK... there are also many trading-oriented brokerages (like Interactive Brokers) that will allow you to buy on foreign exchanges and have foreign accounts but I didn't find them attractive for my purposes.

hpmst3
July 22, 2009 at 11:51 AM

Thanks Sivaram. 

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