Vanguard has recently announced their initial Canadian product line-up – generating mostly luke-warm interest from investors:
“…the initial line-up are likely to be disappointing for investors wanting currency unhedged exposure to US and EAFE markets”
- Canadian Capitalist
“Unfortunately, they also incorporate currency hedging back to Canadian dollars. This takes away the risk protection that I’m looking for…”
- Michael James on Money
“Canadian investors already have an extreme bias to their home market, so when buying foreign equity funds they need meaningful diversification, which includes currency.”
- Tom Bradley, President of Steadyhand Investment Funds
Why have Vanguard’s proposed currency-hedged products been drawing such criticism? The answer may lie in the historical volatility of currency-hedged products in Canada. In the graph below, I’ve compared the historical 3-year rolling standard deviations of two hypothetical balanced portfolios; one with currency-hedged products and one without. As can be seen below, the portfolio that hedged the exposure of foreign currency risk (grey line) has been consistently more volatile than the portfolio that didn’t hedge away this risk (dark blue line) throughout the measurement period.
If investors have historically received a more volatile investment experience by investing in currency-hedged ETFs, perhaps the increased supply of these products lies in their superior past performance. However, the annualized performance of the above hypothetical portfolios from December 2005 to August 2011 (the longest period that both iShares products, XSP and XIN, followed a currency-hedged index), rebalanced annually, would counter this argument. Not only did these currency-hedged portfolios have more volatility on average than their unhedged counterparts (9.32% compared to 7.90%), they also had lower returns (3.75% compared to 3.81%):
In the future, my “Wishlist” from Vanguard would include unhedged versions of their MSCI Total Stock Market ETF (VTI) and MSCI International Stock ETF (VXUS). It is true that these products can already be purchased and sold on the U.S. exchange, but the excessive currency conversion charges levied by our Canadian brokerages can prohibit efficient portfolio construction and tax-loss selling.