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Dale Jackson

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Donít close the barn door just yet

Dale Jackson

For a stark illustration of how our rocket-powered loonie has impacted the average retail investment portfolio take a look at two nearly identical index funds managed by CIBC Securities Inc. The CIBC U.S. Equity Index (US$) fund and the CIBC U.S. Equity Index both track the Wilshire 5000 - an index that represents the entire U.S. market (no foreign based companies). The index includes such baseball and apple pie companies as Exxon Mobile, General Electric and Bank of America.

Where the two funds differ seems slight - especially if you bought it before 2001 when the Canadian dollar had been floundering for years in the 60 to 80 cent range compared with the U.S. dollar. The CIBC U.S. Equity Index (US$) fund is priced in U.S. dollars - with no consideration for currency fluctuations, while the CIBC U.S. Equity Index fund is priced in Canadian dollars.

If you bought the U.S. denominated fund in the fall of 2004, it would have returned an average 12.4 per cent annually. If you had purchased the same fund in Canadian dollars at the same time your return would have averaged a paltry 3.7 per cent annually. Of course that 12.4 per cent return would diminish to around 3.7 per cent if you were to convert it to Canadian dollars now - but the point remains.

CIBC US Equity Index

So unless you've found a way to travel back in time there's nothing you can do now, right? Well, don't close that barn door just yet because the horse isn't entirely gone.

If you held the U.S. denominated fund your losses aren't necessarily locked in and if you held the Canadian denominated fund there is a way to recoup your losses by selling it and going into a U.S. denominated fund.

First of all it's important to realize that you're betting the Canadian dollar is at or near a high and the U.S. dollar is at or near a low. Prudent investment advisors caution retail investors not to speculate on currency fluctuations but in reality we speculate on currency every day by agreeing to be paid in Canadian dollars, and spending and saving Canadian dollars. In other words, that Canadian fiver in your wallet right now is changing its value every second.

The currency fluctuation risk can be reduced if you plan on spending your U.S. dollars in the United States. If you retire or travel south of the border now may be a good time to take those strong Canadian dollars and convert them to a generous amount of U.S. dollars. This is when currency speculation becomes a currency hedge.

Another currency hedge that works at whatever the Canadian dollar is trading is currency diversification. It's always wise to hold a significant portfolio weighting in global equities. Many global equity funds hold stocks in several countries. Each of those stocks is purchased in the national denomination and the companies earnings are often influenced by currency considerations. A French furniture manufacturer, for example, could be suffering from a strong Euro while a similar U.S. furniture manufacturer could be benefiting from a strong greenback if both rely on exports for revenue.

Currency diversification, however, does not always work. The Canadian dollar has been doing well against other currencies such as the British pound, the Euro, the Japanese yen and the Swiss franc. Regardless, spreading your investments out across several currencies increases the odds that fluctuations up or down will be levelled out.

Another possible currency hedge for Canadians is a commodity fund. A large part of the Canadian dollar's strength is derived from the fact the we are a large exporter of Commodities such as oil, and commodities are priced in U.S dollars. The rapid rise in the price of crude oil can be largely attributed to investors cashing in their weak U.S. dollars for something that will retain value.

Gold has traditionally been the best currency hedging commodity since it is considered a currency in itself.

Several commodity funds are available on the market including funds that hold several kinds of commodities or specialized energy, mining of precious metals funds.

For investors who don't want to take on equity market risk, U.S. denominated fixed income and even money market funds are available.

Criterion Investments is one Canadian fund company that specializes in currency hedging by offering a full range of mutual funds with currency hedges as a side feature.

It's often difficult to know if a mutual fund manager hedges currencies. It depends on the company, the manager or the fund. In some cases the currency policy is mentioned in the fund's prospectus but it's best to discuss a currency hedging strategy with a qualified financial advisor.

Dale Jackson has been a producer at Report on Business Television since its launch in September 1999.

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