The following question is from Jamie:
My portfolio is quite similar to your Sleepy Mini Portfolio with a few variations in asset allocation. However, I’ve come across the currency neutral versions of the US and International funds. I’m not sure what the advantages and disadvantages of the three options ($CAD, $USD, Neutral) are and how to evaluate the three funds.
The TD e-Series of index mutual funds has three flavours of funds that track the S&P 500 – TD US Index (TDB902), TD US Index US$ (TDB952) and TD US Index Currency Neutral (TDB904) – and two funds that track the MSCI EAFE Index – TD International Index (TDB911) and TD International Index Currency Neutral (TDB905). TDB952 is different from other funds because it is denominated in US dollars (i.e. you buy using US funds and when you sell you receive US funds) and simply tracks the S&P 500.
TDB902 tracks the S&P 500 in Canadian dollar terms. In other words, the returns obtained from the fund will be the total return of the S&P 500 adjusted for the changes in the Canadian dollar vis-à-vis the US dollar during the same time period. TDB904 hedges the currency exposure for a small extra fee of 0.15% and is designed to provide the same total return as the S&P 500 in its local currency, in this case the US dollar.
For example, let’s say that the S&P 500 was at 1000 and the Canadian dollar at par when you purchased TDB902. One year later, the S&P 500 is at 1100 and the loonie fetches 90 cents US. Your return from the fund, ignoring dividends and assuming there is no tracking error, would be 22%: 10% from the increase in the value of the S&P 500 and 11% from the increase in the value of the greenback. If you had purchased TDB904 instead, you would have made 10% because the currency effect would be hedged away.
Similarly, TDB911 captures the return of the MSCI EAFE Index, which tracks markets in Europe, Japan and Australia, in Canadian dollars and TDB952 hedges the exposure of our dollar to a basket of currencies such as Euros, Pounds, the Yen and the Aussie Dollar.
The fund to use to capture the foreign currency exposure is a matter of personal preference. I personally prefer using unhedged positions because (a) It is cheaper (b) In the long run, currency effects will average out (c) The value of hedging is questionable when a basket of currencies are involved and (d) While currencies on their own have zero expected return over cash, adding them to a portfolio reduces volatility and offers diversification benefits. Admittedly, not hedging the foreign equity positions has not worked out very well in the past few years and you can justifiably hold the opposite view point.