Profit from a strong loonie by investing in the U.S.?
Here's how you can take advantage of the loonie's current strength.
When something’s on fire in the investment world, everyone wants to get in on the action. These days there’s a hot commodity called the loonie. In the rarified world of currency traders each uptick (or downtick, for that matter) makes or breaks fortunes. Frankly, I think of currency traders as mixed martial artists on a high wire.
However, you don’t need to be one of those currency daredevils to take advantage of the loonie’s current strength. After 2007, when the loonie broke through par for the first time since 1976, most folk found profits across the border by shopping malls and gas stations.
While you might save money shopping in the States, there’s little future investment advantage. Instead, consider investing in American companies. Better still, buy companies that pay dividends and have a long history of increasing those dividends.
The future benefit could work like this. Assuming the Canadian dollar settles back below par – and history suggests this is likely – even if a given US stock doesn’t rise in value, you will gain because your investment will be worth more once translated into our currency.
Now, it is certainly possible that if you buy Company A, it might decline in value. But, assuming the loonie does also, you will mitigate the loss on the stock with a gain on the currency.
At the very least, buying US stocks with a strong Canadian dollar reduces overall risk because you have two opportunities to gain – first if the stock rises and second if the loonie falls.
The second benefit lies in dividends. They will be paid out in American dollars and over time you will enjoy a bonus if and when the greenback strengthens.
Skeptics might remind me that past performance is no predictor of the future. True enough. But, since 1950 the Canadian dollar has only flirted with par over three time periods: 1951 to 1961, 1971 to 1976 and 2007 to the present.
Between 1976 and 2007, the loonie was heavily discounted against the greenback. In fact, it was mostly below 90 cents and for a good portion of those years less than 80 cents. The lowest point the loonie hit was 62 cents in January 2002 while the highest, $1.10, occurred was only five years later in November 2007.
While we might yet enjoy quite a number of years with the loonie near or over par, I am betting we will revert to a lower rate eventually.
If you want to invest in the US, assembling a broad range of stocks requires a considerable money and expertise. For most investors purchasing an Exchange Traded Fund (ETF) is the better route. Such ETFs track an index such as the S&P 500 or the Dow Jones Industrial Average for much lower fees than mutual funds.
Unfortunately, ETFs listed in Canada and tracking a US index are hedged to eliminate currency fluctuations (Vanguard Canada is be soon releasing the only non-hedged US ETF.) Hedging has been a popular strategy for investors because the loonie has been rising since 2001. Hedging means that as our currency strengthens the value of the investment doesn’t decline in lockstep.
But now, with a strong dollar Canadians are more likely to see declines in our currency and it could be a better strategy to purchase a non-hedged ETF.
Happily there are many US listed ETFs available. I ran a quick filter on www.morningstar.com and found 98 listed that tracked indices containing large and very large companies. I like these indices for Canadian investors right now because big company ETFs pay dividends and offer a greater return should the dollar decline.
You can get quite a bit of free information on the site simply by registering and there is a dedicated ETF tab. Look for ETFs with dividend in the title. Here are five dividend focused ETFs with 5-star ratings from Morningstar (ticker symbol in brackets):
Vanguard High Dividend Yield Index (VYM, 3.79%)
First Trust Value Line Dividend Index (FVD, 2.6%)
Vanguard Dividend Appreciation (VIG, 2.05%)
SPDR S&P Dividend (SDY, 3.14%)
PowerShares Dividend Achievers (DLN, 2.15%)
Don’t forget that the rate of exchange offered by your brokerage will be different than the so-called “posted rate.” In order to buy at par, for example, the posted rate of the loonie will have to be close to $1.03 against the greenback.
Also, the loonie could rise to $1.10 and stay there for a decade, so don’t bet the farm on this strategy.
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