Volatility certainly has reared its ugly head in 2018. Not only for stocks, but also for currencies. Emerging market currencies are all over the place, with countries such as Turkey and Venezuela experiencing massive devaluations. Even closer to home, the Canadian dollar has experienced a fair amount of volatility, moving up and down with the continuous news flow regarding topics such as interest rates and trade talks.
If every stock you have is in Canadian dollars, then you might not have noticed the fluctuations to a large degree. But many investors wisely wish to adhere to one of the main tenets of investing: diversification. Diversification by industry and geography are good ways to ensure that your portfolio performs well over time. Think of the past few years as an example. If you only had exposure to Canadian equities and little exposure to the United States, you definitely would not have performed as well as you could have.
But how can you have exposure to the United States and the rest of the world and insulate yourself from the ups and downs of currency? One of the best ways is to choose an ETF that tracks an index and is hedged to the Canadian dollar. There are numerous ETFs that can help you to gain exposure to other regions and sectors. The two listed here, iShares Core S&P 500 Index ETF (CAD-hedged) (TSX:XSP) and BMO Euro High Dividend Covered Call Hedged to CAD ETF (TSX:ZWE) should provide exposure to the United States and Europe, while insulating you to a degree from the effects of currency.
Before using a currency-hedged product, you must understand that you may lose out on currency-related gains. If the U.S. dollar appreciates against the Canadian dollar, you will gain both the capital gains from the stock or ETF as well as the gains from the currency. However, if the U.S. dollar depreciates, you will lose currency-related gains. For this reason, a currency-hedged product may provide lower returns but will be less volatile over the long run as compared to its unhedged counterpart.
The XSP tracks the S&P 500, providing exposure to the largest American organizations. This ETF also has the benefit of being one of the largest and most liquid ETFs in Canada. The ETF has had almost an almost 10% compound annual return over the past 10 years. Its management expense ratio (MER) is quite reasonable at 0.11% While it does not have much of a dividend at around 1.5%, this ETF does provide excellent, low-cost returns over the long run.
Europe has many excellent companies to which Canadian investors should consider having exposure. Large, well-known brands such as Unilever (LON:ULVR) PLC make up a large part of the holdings within the ZWE ETF. While this ETF does have a relatively higher MER than a straight index fund like XSP at 0.72%, it does provide a higher distribution of around 6.9%, which is paid out on a monthly basis.
Both of these ETFs will help you to diversify your portfolio away from Canadian companies. If you do not have any international exposure, you should really consider adding an internationally focused ETF such as the ones mentioned here. And if currency fluctuations bother you, using a Canadian dollar-hedged ETF should help you to smooth out the ride over the long run.
Fool contributor Kris Knutson owns shares of BMO EUROPE HIGH DIV CC CAD HEDGE ETF.