Exchange risk on index
Question: When investing in an RRSP-eligible foreign index fund do I get the exchange rate gains along with the index gains? If I do not then how can I, or are there rules against using specific derivatives in the funds? – J.L.
You’ve raised an issue most investors don’t even realize exists. To explain, here’s part of a lengthy article on index funds that appeared in the May issue of the Mutual Funds Update newsletter. If you’re interested in subscribing, you’ll find details on the Web site. – G.P.
From Mutual Funds Update: If you own units in index funds, you may be puzzled as to why some do much better than others, even though they appear to have the same benchmark. For example, the Scotia American Stock Index Fund and the Scotia CanAm Stock Index Fund both track the S&P 500. But the former returned 23.4% over the year to March 31, while the latter gained just 15.1%. Reason: currency movements. The CanAm Stock Index Fund is fully RRSP eligible so 80% of the portfolio is invested in Government of Canada T-bills. When the Canadian dollar dropped in value last year, the fund lost out in terms of U.S. dollar equivalence, and the numr of S&P contracts it could buy based on the value of the T-bills declined as a result. Funds like this need both a rising S&P and a rising loonie to do well.
You’ll find a similar discrepancy between the Green Line International RSP Index Fund (up just 0.1% for the year to March 31) and the CIBC International Index RRSP Fund (up 11.8%). Both are based on the EAFE Index (Europe, Australia and Far East). However, the Green Line fund is denominated in Canadian dollars while the CIBC fund includes foreign currencies. When the Canadian dollar is strong, funds based on the loonie will look better and vice versa.
Our dollar gained back some strength in the first quarter of ‘99, and the results of these two funds show it. The Green Line fund advanced 6.8% during that time, while the CIBC fund lost 0.9%.
So you should never select a fund of this type on the basis of past performance. Currency changes will make a big difference in comparative results. If you think the loonie is going to go higher, or just want to base everything in Canadian dollars, choose a fund like Green Line’s. If you think our dollar will be weak, the CIBC approach will enhance your returns.
And you thought index funds were easy!