Currency Risk

Two returns in one investment

When you hold a foreign asset, two things move at once: the asset's price in its own currency, and the exchange rate between that currency and yours. Your total return in Canadian dollars is roughly the asset return plus the currency return.

Say a US stock gains 10% in US dollars over a year, but the US dollar falls 5% against the loonie. In Canadian dollars, you earned roughly 10% minus 5%, so about 5%. Flip the currency move and the same stock delivers about 15% in CAD. The stock did the identical thing both times; the currency decided how much of it you kept. That second layer of return, good or bad, is currency risk.

Hedged vs unhedged funds

Fund providers sell most popular US and international equity funds in two versions. A currency-hedged ETF or fund uses currency contracts to neutralize exchange-rate moves, so your return tracks the foreign market's local return. The hedge is imperfect in practice and carries a small ongoing cost drag, but it does its main job: the loonie's wanderings mostly stop mattering. An unhedged fund simply holds the foreign assets, so you get the asset return plus the full currency effect, in both directions.

The practical Canadian guidance is fairly even-handed. Over long horizons, currency moves have tended to wash out while hedging costs compound year after year, so many long-term investors hold their US and international equities unhedged and accept the ride. Hedging suits shorter horizons, where a currency swing could land at exactly the wrong time, and investors who simply cannot stomach the extra volatility.

For foreign bonds, the calculus flips: hedging is the standard practice. Bond returns are small and steady, and an unhedged currency can swing more in a month than the bonds yield in a year, swamping the very stability bonds are held for. Most Canadian foreign-bond funds hedge by default for exactly this reason.

The US dollar as an accidental diversifier

Currency risk is not purely a cost. In global panics, money tends to rush into the US dollar while commodity-linked currencies like the loonie fall, so the Canadian-dollar value of unhedged US holdings often drops less than the US market itself, and sometimes barely at all. The currency acts as a shock absorber precisely when you want one. This pattern is general rather than guaranteed, but it is one reason unhedged US exposure has historically added a quiet layer of diversification for Canadian portfolios.

How to tell if your fund hedges

The fund name usually says it: look for "CAD-hedged", "currency hedged", or a ticker variant dedicated to the hedged version. When the name is ambiguous, the Fund Facts document or ETF fact sheet states plainly whether currency exposure is hedged. Many Canadians hold hedged funds without realizing it, or assume a Canadian-listed fund of US stocks is hedged when it is not, so a two-minute check is worthwhile.