The outlook for the Canadian economy is uncertain, and the valuation of EAFE names are not quite as compelling as they were a few months ago, making U.S. equities once again a strong contender. For U.S. exposure, this ETF remains my top pick. It is designed to track the S&P 500 and it fully hedges its currency exposure, so you receive the same return that a U.S. domiciled investor would have received. Intuitively that makes sense, but currency can play a huge role in returns.
For example, in our last Focus List review for the three months ending in January, XSP lost 0.7%, while the average U.S. equity mutual fund had gained an impressive 9.1%. The reason for this huge difference in performance was solely the result of currency, with the Canadian dollar dropping by nearly 12% against the U.S. greenback. Funds and ETFs that did not hedge their currency exposure benefitted from this drop. In the most recent three month period, the opposite happened, with the Canadian dollar gaining nearly 5%. This currency gain ate nearly all of the rise in the market for funds that were unhedged. Looking specifically at XSP, it rose by 4.9%, while the unhedged XSP lost 0.3%.
With the Fed poised to bump rates in the fall and the Bank of Canada likely to stand pat, we may see increasing volatility in the currency, with more pressure likely to the downside. The question now becomes do you hedge or not? Unfortunately there is no right answer to that question and really comes down to your personal preference. If you feel strongly the dollar will fall, then you are better off using XUS over XSP as it provides the same investment exposure, but without the currency hedging. If you expect the dollar to rise, XSP is the way to go. Personally, currency markets are unpredictable and I don’t have a strong sense on what way the dollar will move, making XSP my pick for now.