If you judge by ETF sales trends, pessimism about the loonie is rampant

There are two big decisions to make when searching for an exchange-traded fund to track U.S. or international markets – which index do you choose, and should you go hedged or unhedged?

The index call is a tough one, but sticking to the biggest, most widely followed indexes is usually a good move if you want to keep costs down. Hedging is a guess, though. If the Canadian dollar weakens, then unhedged funds do best. If the loonie takes off, then hedging will protect you from currency-inflicted damage.

Curious what your fellow investors are doing about hedging? If you judge by ETF sales trends, they’re showing a strong preference for no hedging. Here are two examples:

• S&P 500 ETFs: The Vanguard S&P 500 ETF (VFV) has about $2-billion in assets, while the Vanguard S&P 500 Index ETF CAD-hedged (VSP) has $791-million.
• EAFE ETFs (covering the MSCI Europe Australasia Far East Index): The BMO MSCI EAFE Index ETF (ZEA) has about $2.6-billion in assets, while the BMO MSCI EAFE Hedged to CAD Index ETF (ZDM) has about $609-million.

The preference for hedging is likely connected to the Canadian dollar’s long-term slide over the past five years or so against the U.S. dollar. There have been some ups and downs since then, but the loonie’s early March value of 74.5 U.S. cents compares to just above par in February 2013.

Weakness in the loonie over the past year has been a big help to unhedged investors. The S&P 500 lost 2.3 per cent for the 12 months to Jan. 31 in U.S. dollars – that’s your return (minus ETF fees) if you’re using hedging. The S&P 500 gained 4.6 per cent in Canadian dollars – that’s your return if you didn’t use hedging.

Gaps between hedged and unhedged returns for indexes outside Canada can be significant for periods of time ranging from one to five years. But as you get to 10 years and more, the differences become less significant. The S&P 500’s 20-year returns are 5.1 per cent in Canadian dollars and 5.8 per cent in U.S. dollars.

In the short term, following the crowd and not using hedging makes some sense. The loonie has had a nice little run in early 2019, but weakness in the economy could send it lower as the year unfolds.