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How Currency Fluctuations Impact Canadian Investors

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How Currency Fluctuations Impact Canadian Investors

How Currency Fluctuations Impact Canadian Investors

For many Canadians, currency movements are an everyday part of life.

When the Canadian dollar is strong, it means that going south of the border is cheaper. Whether it’s a vacation in Hawaii or a shopping spree in New York City, a strong Canadian dollar can buy more in terms of U.S. dollars.

Likewise, a weak Canadian dollar can buy fewer U.S. dollars – meaning that travel, shopping, and other expenses in U.S. dollars are more expensive.

The Same Effect

The impact of currency fluctuations isn’t limited only to foreign purchases.

In fact, as today’s infographic from Fidelity Investments Canada shows, these same fluctuations can also affect the performance of your portfolio.

Why is that the case?

Many Canadian portfolios have exposure to American-listed companies such as Apple, Wells Fargo, Tesla, or Johnson & Johnson. As a result, fluctuations in the USD/CAD rate can have a profound impact on how these investments perform in Canadian dollars.

How Does This Work?

Here’s an example of the impact of currency in action:

  • A Canadian investor puts $100 CAD into a fund that buys U.S. stocks
  • At the time of investment, $1 CAD buys $0.80 USD
  • After exchange, $80 USD is invested in the U.S. market
  • The U.S. market goes up 10% in one year, and is now worth $88 USD
  • However, over the year, the exchange rate changed to $1 CAD per $0.85 USD
  • Converted back to Canadian dollars, at the new rate, the $88 USD is now worth $103.52 CAD, which is just a 3.5% gain in domestic Canadian currency

In the above case, a strengthening Canadian dollar ends up dampening the returns coming from the U.S. market.

In contrast, if the exchange rate went the other direction – meaning Canadian dollar was weakening – any returns would actually amplify.

Long-Term Planning

If currency fluctuations can have a substantial impact on investments, what does this mean for portfolio construction and assessing risk?

There are two main schools of thought on this:

Hedged: Some funds use a hedging strategy to try and cancel out any currency fluctuations. Ideally, the end result of this would be representative performance of the U.S. market.

Unhedged: This strategy does not try to anticipate currency fluctuations, since the long-term effects of currency movements tend to even out over time.

According to Fidelity Investments Canada, over the 20-year period of November 28, 1997 to November 30, 2017, the impact of currency fluctuations on the S&P 500 had a difference in annualized returns of 0.5%.

In other words, U.S. dollars invested in the S&P 500 had a 7.2% return, while Canadian dollars invested in the same stocks had a 6.7% return after adjusting for exchange rates.

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Investor Education

How MSCI Builds Thematic Indexes: A Step-by-Step Guide

From developing an index objective to choosing relevant stocks, this graphic breaks down how MSCI builds thematic indexes using examples.

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Title text says “How MSCI builds thematic indexes” and funnel is pictured with the following labels from top to bottom: global parent universe, relevance filter, and false positive control.

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The following content is sponsored by MSCI

How MSCI Builds Thematic Indexes: A Step-by-Step Guide

Have you ever wondered how MSCI builds its thematic indexes?

To capture long-term, structural trends that could drive business performance in the future, the company follows a systematic approach. This graphic from MSCI breaks down each step in the process used to create its thematic indexes.

Step 1: Develop an Index Objective

MSCI first builds a broad statement of what the theme aims to capture based on extensive research and insights from industry experts.

Steps 2 and 3: List Sub-Themes, Generate Keyword List

Together with experts, MSCI creates a list of sub-themes or “seedwords” to identify aligned business activities. 

The team then assembles a collection of suitable documents describing the theme. Natural language processing efficiently analyzes word frequency and relevance to generate a more detailed set of keywords contextually similar to the seedwords.

Step 4: Find Relevant Companies

By analyzing financial reports, MSCI picks companies relevant to the theme using two methods:

  1. Direct approach: Revenue from a company’s business segment is considered 100% relevant if the segment name matches a theme keyword. Standard Industrial Classification (SIC) codes from these directly-matched segments make up the eligible SIC code list used in the indirect approach.
  2. Indirect approach: If a segment name doesn’t match theme keywords, MSCI will:
    • Analyze the density of theme keywords mentioned in the company’s description. A minimum of two unique keywords is required.
    • The keyword density determines a “discount factor” to reflect lower certainty in theme alignment.
    • Revenue from business segments with an eligible SIC code, regardless of how they are named, is scaled down by the discount factor.

The total percentage of revenue applicable to the theme from both approaches determines a company’s relevance score.

Step 5: Select the Stocks

Finally, MSCI narrows down the stocks that will be included:

  • Global parent universe: The ACWI Investable Market Index (IMI) is the starting point for standard thematic indexes.
  • Relevance filter: The universe is filtered for companies with a relevance score of at least 25%.
  • False positive control: Eligible companies that are mapped to un-related GICS sub-industries are removed.

Companies with higher relevance scores and market caps have a higher weighting in the index, with the maximum weighting for any one issuer capped at 5%. The final selected stocks span various sectors. 

MSCI Thematic Indexes: Regularly Updated and Rules-Based

Once an index is built, it is reviewed semi-annually and updated based on:

  • Changes to the parent index
  • Changes at individual companies
  • Theme developments based on expert input

Theme keywords are reviewed yearly in May. Overall, MSCI’s thematic index construction process is objective, scalable, and flexible. The process can be customized based on the theme(s) you want to capture.

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Learn more about MSCI’s thematic indexes.

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