COMMENTARY: Currency moves and your investments

(Elvis Picardo is an independent investment strategist located in Vancouver, Canada, and a guest columnist on reuters.com. The opinions expressed are his own.)

By Elvis Picardo

VANCOUVER (Reuters.com) -- Americans planning to vacation in Europe or Canada this summer are likely to face "sticker shock" in an area that is often overlooked - currency exchange.

I allude to the fact that the greenback now buys less of almost any major currency than it did even a year ago. Surging fuel and raw material costs mean that consumers already have to contend with higher prices for everything from airline tickets to suntan lotion. In addition, vacationers will also have to shell out more U.S. dollars in exchange for other currencies such as the euro or the Canadian dollar.

However, the net effect of these currency moves on your vacation costs is small change compared to the impact they can have on your investment portfolio over time. This is especially true because of the extent to which the U.S. dollar has depreciated against most currencies in recent years.

The impact of currency moves on your portfolio can be positive or negative, depending on how your base currency has fared against the currency in which your foreign asset is denominated. For example, U.S. investors who had the foresight to be invested in the Canadian benchmark equity market over the past five years have reaped stellar returns, thanks partly to the currency impact.

Propelled by energy and commodity stocks, Canada's S&P/TSX Composite Index (or the TSX, in short) was up 114.5 percent in the five-year period that ended May 30, 2008. Including dividends, the total cumulative return provided by the TSX was 138.6 percent or close to 19 percent annually over this five-year period.

The Canadian dollar appreciated close to 38 percent over this five-year period, rising from about 73 U.S. cents in May 2003 to just over a U.S. buck in May 2008. The magnitude of this currency gain has turbocharged returns for U.S. investors.

In U.S. dollar terms, the TSX gained 195.4 percent in the five years to May 30, 2008. Including dividends, the total cumulative return was 228.6 percent, or close to 27 percent annually.

In other words, the rising Canadian dollar boosted returns for U.S. investors by an additional 8 percentage points per year.

Over the same five-year period, the S&P 500 rose 45.3 percent; including dividends, it rose 59.4 percent or 9.8 percent annually. This means that in U.S. dollar terms, the TSX outperformed the S&P 500 by a whopping 17 percentage points per year over this period.

So U.S.$10,000 invested in the S&P 500 by a U.S. investor in May 2003 would have grown to U.S.$15,940 (including dividends) by May 2008. But U.S.$10,000 invested in the TSX by a U.S. investor would have more than tripled, to U.S.$32,865 by May 2008.

The flipside of this phenomenon is that portfolio performance can also be weighed down by currency moves. For example, Canadians who were invested in the S&P 500 over this five-year period eked out total cumulative returns of only 15.7 percent. That works out to about 3 percent annually, which is barely in positive territory after adjusting for inflation.

The U.S. dollar is currently at an important inflection point. Market opinion seems to be divided between the likelihood of a further slide in the greenback, and the possibility that higher interest rates going forward may prop up the U.S. dollar and enable it to regain some ground against other currencies.

While forecasting currency movements over the long term is easier said than done, it is an issue that should be given due consideration during the investment planning process. Under the right circumstances, currency moves can provide the icing on the investment cake.