Living on the hedge canadian couch potato world market futures live

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Last week I discussed currency hedging as it applies to international equity ETFs. While iShares hedges currencies in its MSCI EAFE Index Fund (XIN), it does not do so with another of its popular international funds, the MSCI Emerging Markets Index Fund (XEM).

This fund holds stocks in more than 20 countries, and these are denominated in their native currencies: the Chinese renminbi, the Brazilian real, the Indian rupee, and so on usd to inr exchange rate history. So Canadian investors will be exposed to currency risk with this ETF: if the loonie appreciates against any of these foreign currencies, the fund’s returns will be lower. If these foreign currencies strengthen, the returns of XEM will get a boost.

BMO’s entrant in this asset class, the BMO Emerging Markets Equity Index ETF (ZEM), also does not hedge currency and therefore has the same risk exposure.


Not surprisingly, ZEM and XEM have performed almost identically.

However, the Claymore Broad Emerging Markets ETF (CWO) has blown away the iShares and BMO funds dollar vs rupee exchange rate today. Since November 2009, CWO has climbed more than 30%, compared with about 17% for ZEM and XEM exchange rate ksh to usd. What’s the reason for this dramatic outperformance?

Claymore’s CWO simply holds the Vanguard MSCI Emerging Markets ETF (VWO), which is traded in New York in US dollars. According to Claymore’s website, the ETF adds currency hedging “to reduce the direct exposure to non-Canadian dollar currency risk for unitholders of such fund.”

What isn’t clear from this explanation is that CWO’s hedging strategy is pegged to the US dollar, even though the underlying stocks are not denominated in US dollars.

As I explained in last Monday’s post, US-listed ETFs that hold overseas stocks do not expose Canadians to the fluctuations in the US dollar pound usd forecast. Why, then, does Claymore use such a strategy? The reason is that the managers have designed this ETF so it will deliver the same returns for Canadians that its Vanguard counterpart will deliver to Americans.

Because of Claymore’s hedging strategy, Aaron and Carl will enjoy almost identical returns. Betty, meanwhile, will beat them both of them if the US dollar strengthens against the Canadian dollar, but lose to them both if the US dollar weakens.

I stress here that the currency hedging has no relation to the stocks in the fund how does the oil futures market work. It is simply an active bet that the US dollar will decline against the loonie. So far, so good

So far this gamble has worked out extremely well for CWO, because the US dollar has declined almost 17% against the loonie since the fund was launched in July 2009.

I’d be willing to wager, however, that only a tiny number of investors in CWO have the slightest idea how its hedging strategy works. Many probably selected CWO over its competitors because of its recent outperformance euro to inr chart. But this outperformance cannot last indefinitely.

At some point, emerging markets are going to perform well during a period when the US dollar strengthens against the loonie eu to usd. When that happens, investors in CWO will watch the value of their fund lag the index — and most will have no idea why.

It’s great that this hedging strategy has boosted returns for investors in CWO. But I have to question its logic. A Canadian who wants to invest in emerging markets shouldn’t be concerned with the strength of the US dollar versus the loonie text to number converter. These are different investment risks that should have nothing to do with each other. CWO’s strategy makes as much as sense as buying an S&P 500 fund and placing a side bet on the Japanese yen.

@gil: I appreciate that there is historically a negative correlation between the USD and commodity prices, and that this relationship will have some bearing on the performance of an emerging markets fund what are stock market futures. But this rationale is not explained anywhere in CWO’s literature. There is no way that most investors in CWO could even explain this concept, let alone cite it as a reason for investing in the fund.

Let’s be clear: I’m not suggesting that people avoid CWO, only that they understand it before they choose which fund they want for their emerging markets position. I believe that ETF providers should be more transparent about their strategy or they risk becoming active managers.

You say, “So far this gamble has worked out extremely well for CWO, because the US dollar has declined almost 17% against the loonie since the fund was launched in July 2009.”

If CWO is hedged against changes between the loonie and the US dollar, how can a decline in the US dollar vs. the loonie, boost returns of CWO? This seems like a contradiction.

Your example of three investors also states that the American investing in US dollars gets the same return as the Canadian investing in CDN dollars. This backs up your idea that currency fluctuations between the loonie and the US Dollar are hedged, but it contradicts your assertion that CWO is doing better than the other ETF’s because it is hedged against the US dollar.

The boost is coming from the US dollar declining against the other currencies the actual stocks are held in. So when that money is converted back to US dollars (which have declined), the overall return is boosted.

Since the CDN Dollar has held up better against those other currencies, a direct investment using CDN dollars does not get the same currency boost that the US dollars invested in those markets gets.

I have only been “investing” for one year, and have been learning as I go along, by making mistakes in my Questrade account. (I can finally make decisions that are not based on fear, and hold stocks a bit longer.)

Your blog contains the best information I have found so far, for explaining the difference between owning a $US Dollar position or a $CDN Dollar position in ETF.

I recently labored over my decision of weather to purchase a US ETF for Global Infrastructure, or a CDN ETF. I ended up purchasing the CDN CIF ETF: Claymore Global Infrastructure, only because it received 5 stars from Morningstar, and because I am not sophisticated enough to understand the effect that changing currency fluctuations have on the value of the funds. But I knew something was up, that I did not understand.

Also, I am holding off purchasing a Global REIT ETF, because I get nervous trying to figure out whether I should but a US$ ETF or a CDN$ ETF.

Plus, I get confused when I try to consider the other currencies in the other countries, even though I look up those countries in Morningstar and can read the list.

@MyFarirShare: No worries, this is a confusing topic and you’re not alone, but you’ve got it backwards us dollar exchange rate indian rupee. Your exposure is not to the currency the fund trades in: the expsoure is to the currency of the underlying holdings. CGR trades in Canadian dollars, but about half of the fund is in US stocks, so it will do well when the US dollar strengthens relative to the loonie.

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