Canadian investors, faced with domestic markets that are tiny by global standards, must continually ask themselves whether or not to venture into foreign securities. Although the gains to be had can be handsome, investors also risk losing money solely because of the loonie’s fluctuations.

And as investors age, the question becomes more and more difficult to answer with any certainty: is exchange rate risk, with its power to deliver severe damage to a solid portfolio, worth the gamble?

Unfortunately, there are no easy answers for clients who are close to or in retirement; experts differ on the best strategies. But armed with knowledge about the best ways to mitigate exchange rate risk, older investors can make informed decisions when it comes to how much exchange rate risk they should take on — and when they are best advised to keep their foreign exposure very low.

The Canadian dollar can be volatile, and its movements — both up and down — often play havoc with investments.

For instance, solid gains on foreign equities can be wiped out if the currency in which assets are held loses its value relative to the C$; if the C$ falls in value, those losses may be recouped. But predicting the loonie’s trajectory is a dicey game, and the mere possibility of profit in the future is often cold comfort when investors are looking at sinking accounts.

“People dislike losing more than they enjoy winning,” observes Ka-ren Bleasby, senior vice president for investments with Mackenzie Financial Toronto. This is a facet of human nature that those considering investments denominated in foreign currencies need to keep firmly in mind.

The easiest way to avoid the unpredictability inherent in foreign investments is to stick with the safety of buying Canadian securities with C$.

But, as Bleasby points out, that means taking on another kind of risk: too much geographical and sector concentration, especially if strong growth is a goal. Canada comprises only a small fraction of the global equities market, and the Toronto Stock Exchange is overweighted in resources and financial services. The Canadian market has little or no exposure to potentially strong growth sectors, such as health care and technology.

Nevertheless, some experts recommend keeping most of your clients’ investments in Canadian securities when they are close to or in retirement — assuming their living costs are going to be mainly in C$.

Conversely, if your clients are planning to spend significant amounts of time in the U.S., they should have some U.S.-dollar investments in order to generate the income needed to pay US$ expenses.

Nicolas Del Sorbo, senior investment advisor with HSBC Securities (Canada) Inc., says that advisors should take the initiative to raise this point with clients as they near retirement. If necessary, their portfolios should be adjusted to reflect these considerations.

Some clients hope to gain the advantages of foreign exposure with lower risk by using currency hedges. But, like many advi-sors, Del Sorbo is not a fan of retail clients buying currency hedges directly. If your clients are concerned about currency risks, he suggests they buy investments that are already hedged by the investment’s managers.

That’s not the end of the matter, however. If your clients decide to go the hedging route, both they and you must “understand what the fund managers do to mitigate or take advantage of currency movements,” says James Dutkiewicz, head of CI Investments Inc.’ s Signature Global Advisors income team in Toronto. At Signature, the money managers actively manage all currency exposure.

Like Del Sorbo, Dutkiewicz doesn’t suggest direct currency hedging.

“It’s difficult and expensive for retail investors to hedge currency exposure themselves,” he says. “They don’t have the scale to enter into forward hedging contracts.”

Adrian Mastracci, a portfolio manager and president of KCM Wealth Management Inc. in Vancouver, suggests that your clients should venture into foreign securities. In order to mitigate the risks, he recommends currency-hedged exchange-traded funds or currency-hedged index funds. He says this works well for his clients because he tends to use ETFs for much of their equities exposure.

However, Mastracci points out, if your client’s international equities exposure is only 10% of total assets, he or she may not feel that enough is at stake to justify the sometimes significant cost of hedging.

@page_break@If hedging is sought in this kind of situation, it’s easiest to hedge U.S. equity investments. Mastracci would recommend hedging those investments for these types of clients.

For all clients with international exposure, it is vitally important to ensure that they understand how deeply currency fluctuations can bite. Gaetan Ruest, director of strategic investment planning with Investors Group Inc. in Winnipeg, cautions that currency risk can be a “deep cycle” risk — that is, unlike market risk, which tends to be relatively short-term, he says, “It can take decades to recover from a big movement in a currency.”

For instance, a US$10,000 investment would have been worth around $15,700 in 2002, when the C$ was trading at an average level of US63.7¢. By 2008, a US$10,000 investment would have been worth only $10,660, given the strong appreciation in the C$ to US93.8¢.

This leads to the question of how much of their holdings your clients should hedge. Bleasby says the answer is probably 30%-50% of their total market exposure.

That estimate is based on academic studies, as well as the fact that bouncing currencies can have a negative impact on portfolios for a long time. In other words, she says, “It’s better to be partly right than all wrong.”

One thing about foreign investments on which there is broad agreement is that although currency risk should be taken into consideration, it should never be the primary reason for buying a particular equity product.

Instead, investments should be chosen for their underlying value; any hedging around those products should be a secondary consideration. IE