Depending on exchange rate shifts, stock markets such as that of the U.S. can provide either currency gains or a drag on returns. That need not be the case if the currency exposure is hedged back to the Canadian dollar, leaving U.S. equity investors exposed to what the stocks do but guarding against a weakening greenback.
Many ETF providers take the approach of providing choice to investors by offering both hedged and unhedged versions of their U.S. equity strategies.
“On a hedged basis, we’re just tracking the moves in equity prices, but we’re obviating the foreign exchange risk,” said Bipan Rai, head of ETF and alternatives strategy at BMO Global Asset Management. “Whereas for unhedged exposure, we are leaving that exposure to movements in the U.S. dollar relative to the Canadian dollar. And so that does add an additional layer of risk and potentially another source of return.”
Over the past year and a half, Canadian ETF investors have done well investing in U.S. equities, and those who held currency-hedged products did even better. In early 2025, a U.S. dollar was worth $1.44 Canadian, five cents higher than its recent level.
At roughly $1.395 Canadian per U.S. dollar, the loonie is near the weak end of its typical post-1970 trading range of about $1.11 to $1.43, though still well above its record low of approximately $1.62 reached in 2002.
Could Canada’s currency continue to appreciate versus the U.S. dollar? That’s the current projection of RBC Global Asset Management (GAM) Inc. In late May, RBC GAM revised its 12-month forecast for the Canadian dollar to $1.30 per U.S. dollar, predicting a broadly weaker greenback.
This bullish forecast for the Canadian dollar, according to RBC GAM, “would depend on a clearer path toward finalizing a North American trade agreement, a relatively low number of mortgage defaults as Canadians refinance mortgages at higher rates and investor optimism that the Bank of Canada will pivot to rate hikes.”
Given that the current exchange rate is close to a multi-year low for the loonie, it makes sense to hedge a part of U.S.-dollar exposure, said Aubrey Hearn, senior vice-president and lead portfolio manager of U.S. and small-cap equities with CI Global Asset Management.
The increased level of fiscal spending in Canada, said Hearn, “should help improve Canada’s [gross domestic product] growth rates over the medium to longer term, which should lead to a slow increase in the Canadian dollar.”
BMO GAM’s Rai favours taking a short-term tactical approach to currency-hedging decisions. “It’s very, very difficult to call directionality in [exchange rates] over the long term and expect to earn some degree of excess return.” He said considering hedging decisions on a three- to six-month basis “is far more healthy than, say, on an annual or two-year basis.”
A key consideration for Rai is what the U.S. Federal Reserve and the Bank of Canada are likely to do regarding rate hikes, and what expectations the currency markets are pricing in.
In late May, the currency swap markets were pricing in 27 basis points of further tightening by the Fed by year-end and a 34-basis point increase for the Bank of Canada.
But BMO GAM strategists believe there’s probably a stronger case to be made for a Fed rate hike than one in Canada. This implies a strengthening U.S. dollar, since higher rates will make the greenback more attractive. But, “that could obviously shift tomorrow or the day after,” Rai said.
Hedging costs
Along with the potential missed opportunity if the U.S. dollar appreciates from its current level, currency hedging involves additional costs. Not in terms of management fees, which are generally the same for hedged and unhedged ETFs, but because of transaction and interest costs.
To achieve currency hedging, ETFs must take positions in currency forwards or futures contracts. The transaction costs of these derivatives tend to be small, somewhere in the range of a few basis points for institutional trades.
The much more significant drag on returns is carrying costs. To hedge back to Canadian dollars through derivatives, the fund manager is effectively borrowing U.S. dollars and selling them in exchange for Canadian dollars, which are then invested at short-term rates.
Since risk-free U.S. interest rates are about 150 basis points higher than in Canada, “the cost of carry is really the dominant cost of the currency hedge,” said Stephen Hoffman, managing director of ETFs at RBC GAM.
Historically, over longer multi-year periods, unhedged U.S. equity ETFs have outperformed their hedged counterparts — often by a significant margin.
For example, the unhedged BMO S&P 500 Index ETF, which has no currency-carrying costs to bear, has a 10-year annualized return to April 30 of 15.8%. That’s more than two full percentage points higher than the BMO S&P 500 Hedged to CAD Index ETF’s 13.4% return over the same period.
“There is certainly a case to be made about leaving a currency unhedged,” said Hearn. “Over longer periods of time the currency tends to fluctuate but balances out over time.”
He noted that over the last several years, the U.S. economy and consequently U.S. companies have been an attractive place to invest. Recently, to reflect this strength, the U.S. dollar has appreciated versus most other major currencies. “If that relationship holds going forward, it could make sense to have exposure to the U.S. dollar,” Hearn added.
Not hedging, fully hedging and tactical hedging are several main approaches that investors can take. Another to consider is hedging 50% of the total U.S.-currency exposure, while leaving the other half unhedged. “It’s the portfolio of least regret,” Hoffman said. “You’re always going to be at least half right.”
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