US equities

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US equities are generally purchased by Canadians to provide portfolio diversification. International equities and emerging markets markets are considered in separate sections.

US equities are often benchmarked against the Standard and Poors 500 (S&P 500) Index,[1] which comprises 500 of the largest stocks by market capitalization that trade on US stock exchanges.

Currency hedging

Main article: Currency hedging

Currency hedging refers to the practice of removing the effects of currency fluctuations from the returns obtained by a holding that is valued in a different currency. For example, if a Canadian investor purchased a US-based fund tracking the S&P500 (and thus valued in US dollars) and the index went up 10% but the Canadian dollar also went up 10% versus the US dollar, the currency change would cancel out the valuation change. A currency-hedged fund would, if the hedging was performed perfectly and at zero cost, cancel out the rise in the Canadian dollar, in this case enhancing the observed return. However, if the Canadian dollar were to fall, a currency-hedged fund would return less money.

Although it is possible for investors to purchase currency-hedged versions of some mutual funds and ETFs, the costs of currency hedging are a matter of some dispute. They have been estimated by adviser Dan Hallett, who recommends currency hedging for those investors who wish to have the currency protection, as 0.4 to 0.5%[2] A tracking-error comparison between the iShares S&P 500 Index Fund (CAD-Hedged) ETF XSP and the S&P500 is shown below.[3] This tracking error, which includes the total of the 0.24% MER, currency hedging costs, and any portfolio mismatching amounts to about 1% per year according to the BlackRocks's data:

Note that prior to November 15, 2005, the investment objective of XSP was to replicate, to the extent possible, the performance of the S&P 500 Index. After November 15, 2005, the investment objective of XSP is to provide long-term capital growth by replicating, to the extent possible, the performance of the S&P 500 Hedged to Canadian Dollars.[4]

XSP Tracking Error to 31-Dec-2011.PNG

Another tracking error chart can be obtained from BigCharts,[5], and is shown below. This chart suggests an error of about 2% per year:
Xsperr.gif

An up-to-date version of the BigCharts graph can be obtained in this link. Although the two graphs disagree significantly in the size of the total tracking error, it is nevertheless clear that currency hedging will add significant costs above the 0.24% MER.

It should also be noted that investors who face significant US-dollar expenses - say, for "snowbirding" in the US - may not wish to hedge so that the currencies of their investments better match the currencies of their expenses.

A classic argument in favour or currency hedging it that it lowers volatility, but this is apparently not true for Canadians purchasing foreign stocks [6]

Mutual funds and exchange-traded funds

Many actively managed Canadian mutual funds are available that allow Canadians to purchase US equities. Passively managed index funds or exchange-traded funds (ETFs) are also available. A notable index fund is the TD U.S. Index Fund - e, Fund Code TDB902.

The Canadian arm of BlackRock, Inc. offers the iShares Core S&P 500 Index ETF (CAD-Hedged), TSX symbol XSP, which is a currency-hedged version of the US ETF IVV, which covers the S&P 500. The unhedged alternative is XUS.

A more recent entrant to the Canadian market, in late 2011, is Vanguard Canada and the Vanguard U.S. Total Market Index ETF (CAD-hedged), TSX symbol VUS, which is a currency hedged version of the US ETF VTI, which covers the entire US market. An unhedged version is the Vanguard U.S. Total Market Index ETF (VUN). S&P500 ETFs are also available there, both hedged and unhedged.

BMO Exchange Traded Funds offers the BMO S&P 500 Index ETF (ZSP) and a hedged version (ZUE), among others.

US stock exchanges offer ETFs that cover not only the S&P 500 Index but a wide variety of subindexes, investment styles, and sectors. Notable US ETFs include SPY, which covers the S&P 500, and VTI, which covers the entire US market.

Canadian investors can access these US ETFs through their discount brokerage, but face currency conversion costs unless the ETFs are held in a US-dollar account.

US stocks

US stocks can also be purchased directly by Canadian investors who wish to practice their own stock selection.

See also

References

  1. Wikipedia, S&P 500, viewed March 12, 2009.
  2. Rob Carrick, The pluses - and minuses - of currency hedging, Globe and Mail, June 6, 2009. Viewed August 15, 2009.
  3. BlackRock Asset Management Canada Limited, Tracking Error Charting Tool, XSP, viewed January 16, 2012.
  4. XSP - iShares S&P 500 Index Fund (CAD-Hedged) Annual MRFP, viewed January 16, 2012
  5. BigCharts, plot of CA:XSP versus S&P500, viewed January 17, 2012
  6. Canadian Couch Potato, Why Currency Hedging Doesn’t Work in Canada, viewed Dec. 27, 2014