If you are Canadian and you own anything outside Canada, part of your return comes from the asset and part comes from the currency. Most people never separate the two, which means they never work out that the currency is often doing them a favour.
When a Canadian buys a US-listed stock, they make two bets whether they intend to or not: one on the company, one on the US dollar against the Canadian dollar. The combined result is close to additive:
A US stock rises 10% in USD. If the US dollar also strengthens 5% against the loonie, the Canadian investor made about 15%. If instead the loonie strengthened 5%, they made about 5%. Same company, same year, a three-fold difference in outcome from a variable most people never look at.
Currency is genuinely volatile — USD/CAD commonly moves 5–10% in a year and has moved far more. Over a single year it can swamp the asset return entirely. Over multi-decade horizons its contribution tends to wash out, since currencies fluctuate around long-run relationships rather than trending indefinitely. The horizon matters enormously to how much you should care.
Here is the part that most Canadian investors have never had explained, and it is genuinely good news.
The Canadian dollar is a risk-on currency: it is tied to commodity prices, particularly oil, and to global growth expectations. The US dollar is the world’s reserve currency and a safe haven — in a crisis, global capital moves toward it. So when equity markets fall hard, two things typically happen at once: stocks drop, and the CAD weakens against the USD.
For a Canadian holding unhedged US assets, those two effects partially offset. The US holding falls in USD terms, but each of those USD is now worth more loonies. In 2008 and again in March 2020, Canadian investors holding unhedged US equities experienced meaningfully smaller declines in CAD terms than US investors experienced in USD terms.
This has an important consequence that runs against intuition: for a Canadian equity investor, unhedged foreign exposure has historically reduced portfolio volatility rather than increased it. Adding a currency that strengthens when your equities fall is diversification, not extra risk. It is the rare case where doing nothing — not hedging — is the risk-managed choice.
A currency-hedged ETF uses forward contracts to strip out the currency move, so you get approximately the foreign asset’s return in local terms, translated at a fixed rate. Many popular funds offer both versions — often the ticker with a “.TO” listing and a hedged variant sitting beside it.
| Unhedged | Hedged | |
|---|---|---|
| You are exposed to | The asset and the currency | The asset only |
| In an equity crash | Loss cushioned by a weakening CAD | Full loss, no cushion |
| If the CAD strengthens | Returns reduced | Protected |
| Cost | None beyond the fund MER | MER plus hedging cost — interest-rate differentials, roll costs, tracking error |
| Tracking | Clean | Imperfect; hedges are reset periodically and drift between resets |
Hedging is not free, and its costs are mostly invisible. They show up as a persistent, small drag rather than a fee line: the interest-rate differential between the two currencies, the cost of rolling forward contracts, and tracking error from hedges that are rebalanced monthly while markets move daily. Over long periods that drag compounds against you, and you are paying it to remove a risk that — for Canadian equity investors — was partly working in your favour.
The distinction that matters is between foreign bonds and foreign equities.
Hedge foreign bonds. Almost always. The entire reason to hold high-quality foreign bonds is stability and low volatility. Currency volatility of 8–10% completely overwhelms a bond’s 3–5% volatility, and you end up with an asset that behaves nothing like the bond you bought. Hedging restores the reason you bought it.
Usually do not hedge foreign equities. Equity volatility of 15–20% is large relative to currency volatility, currency effects wash out over long horizons, hedging costs compound, and for Canadians specifically the unhedged currency exposure has provided a genuine crash cushion.
Three situations that change the answer:
Separate from the risk question is the friction question, which is where Canadians lose real money quietly. A retail bank or brokerage typically charges 1.5–2% on a currency conversion, buried in the exchange rate rather than shown as a fee. Convert $50,000 and back and you have paid roughly $1,500–2,000 for the privilege.
Norbert’s gambit — buying an interlisted security in one currency and journalling it to the other side to sell — reduces that to a couple of commissions. It requires a brokerage that supports journalling and a few days of settlement patience. There is a full walkthrough in the Master Your Money lesson on withholding tax and Norbert’s gambit, which also covers the related question of which account to hold US dividend payers in.
Country risk is everything that can go wrong at the level of a jurisdiction rather than a company: policy and regulatory change, capital controls, expropriation, weak or unevenly applied shareholder protections, accounting standards you cannot fully rely on, political instability, and sanctions.
It matters because it is not diversifiable within that country. Owning thirty companies in one jurisdiction does not protect you from a rule change that applies to all thirty. A very good business in a jurisdiction where minority shareholders have weak recourse can be a poor investment for reasons that never appear in the financial statements.
This is the argument for holding developed-market exposure as the core and treating emerging markets as a satellite, sized deliberately. It is not an argument against emerging markets — they carry genuine growth and genuine diversification — but the risk being taken is different in kind from company risk, and the position size should reflect that. Module 5’s risk-budget method handles it cleanly: a larger plausible decline produces a smaller position, automatically.
Educational purposes only; not financial advice. Historical figures are illustrative and past drawdowns are not a forecast of future ones. Always do your own research and consult a licensed advisor.