Currency Options University – Part 2

Part 2: Impact of U.S. Dollar Fluctuation on Canadian Returns

I had the opportunity, early in my career, to work at a full-service brokerage at a Tier 1 Canadian bank. I remember back in the day overhearing an investment advisor having an argument with a client about the client’s performance. The client was questioning the overall performance when looking at the value of the portfolio in Canadian dollar terms. The advisor was defending himself saying that he was a value investor/stock picker and not a currency trader. At the time I was just learning the ropes and did not fully comprehend the statement.

Currency matters!

It was only years later that I started to understand the macro implications. A weak currency not only acts as a stimulation for a country by making its exports globally more competitive but also often drives its stock markets higher. Let’s try to understand this in more detail.

Our focus here is to cherry pick a real example of how dramatic the returns can be between two investors by a simple decision as to what currency to buy their shares in. I am going back to the 2013 to 2016 period to intentionally capture a meaningful move in the Canadian dollar. For this example, both our investors are keen on owning Royal Bank for both the dividend and upside appreciation.

Back on January 4, 2013 the U.S. dollar was trading near par at 0.9874 to the CAD.

Investor A: Our first investor has a Canadian dollar margin trading account and decides to buy 1,000 shares of Royal Bank (TSX:RY) back on January 4, 2013 at $61.07, which amounts to a $61,070.00 investment made in Canadian dollars. 

Investor B: Our second investor has an American dollar margin trading account and also decides to buy 1,000 shares of Royal Bank (NYSE:RY), but does so on the New York Stock Exchange. The shares are purchased on January 4, 2013 at $61.86, which amounts to a $61,860.00 investment in U.S. dollars.

Both investors bought the company for the same reason. A safe dividend and long-term appreciation. The final result proved to be far more divergent than most would think.

The difference?

The U.S. dollar appreciated from 0.9874 to 1.3122¹ over that timeframe. Now the intelligent and thorough investor may argue that they were no better or worse off if everything was converted back to a Canadian dollar base, but I digress.

How many U.S. dollar denominated investors would feel satisfied that they made a sound investment in Royal Bank shares (NYSE) if they saw no capital appreciation in close to 4 years?

Equally, how many Canadian dollar denominated investors would argue that they were not really up 33.06% on their shares because they lost it on the purchasing value of their domestic currency?

Is it not fascinating how different investors could have such different perceptions on their returns owning the same shares?

The currency you own your investments in is incredibly influential to your final performance. Taking a macro perspective on understanding currency risks is critical for an aspiring investor. Learning when and how to hedge those risks is a valuable tool in helping manage those risks.

Join us for Part 3 where we will take a deeper dive into understanding the specifications of currency options, how they work and if they are right for you.

Disclaimer:

The strategies presented in this blog are for information and training purposes only, and should not be interpreted as recommendations to buy or sell any security. As always, you should ensure that you are comfortable with the proposed scenarios and ready to assume all the risks before implementing an option strategy.