With the Canadian dollar running neck and neck with its U.S. counterpart, investors in Canada are becoming increasingly aware that exchange rate movements can have a strong impact on their foreign-currency-denominated investments.

Although some financial advisors are directing their clients into investments such as hedged mutual funds that offer immunity to currency moves, in case the C$ continues to rise, others feel that the C$’s current strength makes now an opportune time to beef up the foreign asset allocation in client portfolios heavily in the home market.

Just as Canadians take advantage of a strong C$ to go shopping outside our borders for electronics, clothes and vacations, they can also benefit by spending strong C$ on foreign investments.

“The Canadian currency is expensive on a relative basis,” says Tye Bousada, founding partner and co-CEO of Toronto-based Edgepoint Investment Group Inc.Edgepoint was hedging when the C$ was weaker, but has been incrementally reducing its hedging as the currency has risen.

“If you want to buy a major item, such a computer or a vehicle, made in the U.S., it makes sense to buy it now as our currency goes a lot further,” he says. “The same goes for buying a piece of a business, which is how we view buying stocks.”

The risk is that the C$ could rise further, eclipsing the U.S. dollar. A rising C$ erodes the value of investment gains made in international markets once those proceeds have been converted back our domestic currency for Canadian investors.

Conversely, when foreign currencies, such as US$, are gaining in value against the loonie, these currency gains enhance the returns made in foreign markets by investors in Canada.

The problem is that currency movements are unpredictable — and some investors are beginning to view exchange rate moves as a risk to be managed.

“Currencies are notoriously difficult to predict and are influenced by a complex set of global factors that can cause sharp swings in the short to medium term,” says Dan Hallett, director of asset management with Oakville, Ont.-based HighView Financial Group in Windsor, Ont. “While the moves tend to balance out in the long term, a lot of people lose patience waiting.”

Looking into the rear-view mirror, recent gains in the C$ have had a negative effect on Canadian investors venturing outside our borders.

For example, Dynamic American Value Fund, sponsored by Toronto-based Dynamic Funds Ltd., gained 28.1% in the year ended Feb. 28, after the return was converted back to C$. But the same portfolio denominated in US$ managed a much stronger gain of 54.7%.

“Currency has a profound effect on returns for investors,” says Rudy Luukko, investment funds editor with Morningstar Canada in Toronto. “During the past 12 months, depreciation of the US$ has slashed in half the returns made in the U.S. market for Canadian inves-tors vs investors in U.S. currency. There has definitely been a performance edge for [money] managers who hedge.”

Broader indices show a similar pattern. For the year ended Feb. 28, the S&P 500 total return index gained 54%, but once converted to C$ for Canadian inves-tors, that return shrivelled to 27% as the C$ strengthened. During the longer period of the past decade, exchange rate moves were also hurtful. Although the S&P 500 showed a loss of 0.3% for the 10 years ended Feb. 28, that turned into a loss of 3.4% in C$.

A handful of investment fund companies offer products that use hedging strategies to neutralize currency swings, and as the strength in the C$ continues, interest in their offerings is growing. This past autumn, Invesco Trimark Ltd. and Fidelity Investments Canada ULC introduced new currency-neutral funds. Also offering currency-neutral funds are TD Asset Management Inc., Mackenzie Financial Services Inc., Criterion Investments Inc. and RBC Asset Management Inc. (All firms are based in Toronto.)

A variety of exchange-traded funds also come in currency-neutral versions, including foreign-focused ETFs offered by iShares Funds Canada (a division of BlackRock Asset Management Canada Ltd.), Claymore Investments Inc. and Bank of Montreal. (All firms are based in Toronto.)

“The hedged ETFs allow inves-tors to gain exposure to a particular market, but not to the currency,” says Som Seif, Claymore’s president.

Fidelity was a pioneer in launching currency-neutral products four years ago, with the introduction of hedged versions of Fidelity American High Yield and Fidelity Global Bond funds. This past October, Fidelity launched American Disciplined Equity Class, International Disciplined Equity Class and Global Disciplined Equity Class. Fidelity has also launched five currency-neutral pools within its private investor program, including equity and balanced pools.