How to make the high loonie work in your portfolio - LORI MCLEOD

The soaring loonie may be taking a big bite out of your portfolio of U.S. stocks, but instead of bringing it all home, investment advisers say you should consider bulking up on cheap American equities and greenbacks.

The Canadian currency is unlikely to stay at its current $1.07 (U.S.) in the long term, and patient investors could cash in when it declines.

“One of the things I'm looking at doing now… is simply moving Canadian money to the U.S.,” said Drew Abbott, vice-president and investment adviser at TD Waterhouse Private Investment Advice.

While it's a moving target, Mr. Abbott said he expects the loonie to settle in the 95 cent to $1 range within the next 18 months.

“Even if you put that into a U.S. money market fund earning 5 per cent, if the dollar comes back down from $1.07 to $1, that's a 12-per-cent return over a year. The major move's obviously been done. Whether we're timing it properly is impossible to tell, but that's one strategy.”

It's an encouraging piece of advice in what has been a tough market for investors who thought they were doing everything right by diversifying their investments. It's a trend that really started to take hold in Canada after the 30-per-cent foreign content limit on RRSPs was dropped in 2005 and a wealth of global investment products entered the market.

Now, as the dollar soars on the back of high oil prices, these careful investors have seen the value of their holdings drop in tandem with the U.S. dollar, and dramatically underperform the TSX.

What it all boils down to is a loonie that has defied expectations, climbing from 62 cents in the past five years, an increase of 70 per cent.

Rising oil prices, weakness in the U.S. and Canada's overall economic strength have combined to make the loonie the world's best-performing currency so far this year, up 7 per cent in the past month alone.

It's a mixed blessing for Canadians investing in other countries, who on the positive side can now purchase more stocks, real estate or U.S. dollars for their loonies. However, losing so much ground on currency losses while local stocks rise can be difficult to ignore.

“Some people get frustrated, especially those that chase the limelight and always want to be in the hottest sectors. They're the ones who look at their U.S. stocks and say ‘What have you done for me lately?'” said Murray Leith, director of research at Vancouver-based investment adviser Odlum Brown Ltd.

Forty per cent of Odlum Brown's equity holdings are outside of Canada, and their returns are taking a direct, currency-related hit as a result. Returns are in the 2- to 3-per-cent range so far this year, compared with 11 per cent for the Toronto Stock Exchange.

In some ways, those trying to chase the loonie aren't unlike technology investors late in the 1990s. In that boom Mr. Leith stuck it out with “boring, Old Economy” stocks he believed offered good value, to the dismay of some of his investors.

“For our clients, '99 was a tough year. We were up 20 per cent, but not the 33 per cent the TSX was up, and that frustrated some people.”

Then Odlum Brown slapped its first sell recommendation on Nortel in June of 2000, when it was trading at $75 a share. Telecom companies were spending freely despite their deteriorating businesses and horrible balance sheets, said Mr. Leith, who believed they would soon become unable to buy Nortel's equipment.

Yet before its infamous correction Nortel stock kept on climbing to $125 a share, taking some of Mr. Leith's hair along with it as he tugged it out in dismay.

However, sticking to his strategy has also protected his clients against downturns, buffering them when technology stocks eventually headed south.

Mr. Leith said he'll continue to look for U.S. stock deals while his loonies stay strong, and he is particularly interested in firms that cater to the aging population, such as health care companies.

One of the keys to investing well in this tumultuous market is to have patience and resist the urge to yank all of your funds back to Canada, said Irwin Michael, portfolio manager at ABC Funds.

“In the short run, you may be hurt by staying offshore or in the United States, but in the long run you'll do well with U.S. stocks. You can take your $1.06 or $1.07 and buy some pretty cheap stocks in the United States but you need staying power and patience, and a lot of people don't have that,” he said.

The Canadian dollar may not curb its run in the next few weeks or even years, and could even gain slightly in the short term, said Douglas Porter, deputy chief economist at BMO Nesbitt Burns Inc. In the very long term, however, the loonie will likely settle somewhere between the mid-80s to mid-90s depending on commodity prices, he said.

“Over the longer haul this is a golden opportunity to at the very least consider slightly increasing holdings in foreign securities. We've had an unbelievable run between the Canadian dollar and the TSX over the last five years, and I just cannot believe we're going to have another prolonged period like that of extreme outperformance,” Mr. Porter said.

For Michael Morrow, who runs a financial planning business in Thunder Bay, the value of diversification has only been hammered home by the loonie's rise. By choosing to invest in funds with strong managers, Mr. Morrow said he and his clients are buying years of “collective wisdom,” one benefit of which is that they were approximately 50 per cent hedged against the currency increase well before the loonie's recent flight.

“The safety net that I've built in is that we're very, very broadly diversified and putting our money with more than one portfolio manager,” he said.