International Equities

Introduction

International equities are generally purchased by Canadians to provide portfolio diversification. International equities, in traditional definitions, are all equities outside the US, or North America. The definition of global equities includes US stocks. This section will consider non-US holdings, excluding emerging markets. US equities and emerging markets are considered in separate sections.

International equities are often benchmarked against the Europe-Australia-Far East Index (EAFE Index).

Mutual Funds and ETFs

Many actively managed Canadian mutual funds are available that allow Canadians to purchase foreign equities. Passively managed index funds or ETFs are available not only in Canada, but on US stock exchanges, where ETFs cover not only the EAFE Index but regional or country-specific indexes. The Canadian arm of BlackRock, Inc. offers the iShares MSCI EAFE Index Fund (CAD-Hedged), TSX symbolXIN, which is a currency-hedged version of the EAFE Index, and the iShares MSCI World Index Fund, TSX symbol XWD, which replicates the MSCI World Index. A more recent entrant to the Canadian market, in late 2011, is Vanguard Canada and the MSCI EAFE Index ETF (CAD-hedged), TSX symbol VEF.

For many international ETFs, Canadian investors must go to a US exchange. They can get access through their discount brokers, but face currency costs. It is easier to get access to international ETFs in the US because the big brokerage houses have operations across the globe, and thus relations with clearing and settlement facilities operated by different exchanges, as well as with the custodial banks in different countries that track which investor owns what. With their scale, the big US brokerages can arbitrage price differences across various countries (some stocks are interlisted) as well as differences between an ETF and its component securities, thus keeping the price of the ETF in line with its constituents. US-based ETFs that cover the EAFE Index include the iShares ETF EFA and Vanguard's VEA. A total-world stock ETF with the symbol VT and an all-world ex-US ETF with the symbol VEU are also available from Vanguard; these ETFs have a small Canadian component, although the Canadian section is not tax-efficient because it does not qualify for the dividend tax credit.

Canadian banks, while adept in the domestic market, are only slowly extending these arbitrage capacities, which makes for a more limited direct international exposure in the Canadian ETF marketplace. For example, the Canadian arm of BlackRock, Inc., which markets the popular iShares family, generally invests its Canadian-domiciled international funds in units of BlackRock's US iShares. Claymore, which also offers international funds, gets some of its exposure through American Depositary Receipts, which are almost frictionlessly cleared and settled back and forth across the Canadian and US border thanks to long-standing interlisting practices, whereby a stock such as Tim Horton's or Potash would trade on both Canadian and American stock exchanges.

American Depositary Receipts (ADRs)

An American Depositary Receipt, or ADR, is a certificate representing a shares in a non-US stock. These certificates trade on US stock exchanges and allow individuals to purchase shares in non-US companies such as Toyota or Nestle without having to access overseas stock exchanges — and their clearing and settlement systems. The largest supplier of certificates is The Bank of New York Mellon, which is also among the biggest share custodians in the world. A custodian looks after record-keeping and corporate events such as dividend payments for the owners of the shares, be they individual investors or pension or mutal funds. ADRs represent shares that are custodialized in an American bank — just like domestic shares — but they are traded much like ETFs, with market-makers buying and selling creation units to arbitrage price differences between the underlying stock price and what is bundled into an ADR.

Tax Implications

US-domiciled ETFs that are held in registered accounts may have tax withheld in the US. If so, this tax will not be recoverable in Canada.

Foreign holdings must be reported to CRA if they total over $100000.

Currency Implications

One common misconception is that owning an ETF that trades in US dollars necessarily exposes the holder to the effect of the Canadian-US dollar exchange rate. In fact, the US dollar exposure cancels out for securities that are denominated in other currencies. To see this, consider the case of a US-dollar denominated ETF or ADR that holds a security denominated in pounds sterling. For simplicity, suppose the US dollar and Canadian dollar are at parity and the exchange rate from the US dollar to the pound is exactly 2:1. A security valued at £10 would thus be worth $20 US and $20 Canadian. Suppose that the Canadian dollar and pound sterling then both depreciated by 20% versus the US dollar, with the new exchange rates being 1 GBP = $1.60 US and 1 C$ = $0.80 US. The security would now be worth only $16 US (10 × $1.60). But since the Canadian dollar would now be worth only $0.80 US dollars, the $16 US would now be $20 Canadian - and the value of the security in Canadian dollars would not have changed because the Canadian dollar to pound sterling exchange rate was unchanged.

Mathematically, the exchange rates in this case can be calculated as follows:

GBP/US$ × US$/C$ = GBP/C$

so the US dollar cancels out. Similarly, US-dollar-traded securities priced in other currencies - Euros, yen, Swiss francs, Australian dollars, etc. - will also reflect currency fluctuations only with respect to the exchange rates of the pricing currencies versus the Canadian dollar.