Archive | February, 2015

Taxable Consequences of Norbert’s Gambit

Norbert’s gambit with the Horizons US Dollar Currency ETF (DLR/DLR.U) is often the most cost-efficient way to convert Canadian dollars to US dollars, or vice-versa. Our series of white papers focused on performing the gambit in an RRSP, but if you’re swapping currencies in a non-registered account, you should be aware that it can have tax consequences.

At brokerages such as RBC Direct and BMO InvestorLine, you can place the buy and sell trades within minutes of each other. But several other brokerages do not allow you to journal the ETF from the Canadian side of your account to the US side (or the other way around) until the buy trade settles. In both cases, however, there will be at least three business days for the transaction to be complete, and the US-Canadian exchange rate can move significantly during that time. A big swing could stick you with a capital gain or loss when you make the sale.

What’s more, calculating this gain or loss can be tricky, because both the purchase and sale need to be reported in Canadian dollars. That means any transaction in DLR.U needs to be converted from US dollars.

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iShares Expands Its Core ETF Lineup

iShares shook up the ETF marketplace last March when it launched its Core family of low-cost ETFs in the major asset classes. This week iShares announced some new additions to its Core lineup, including two broad-market funds that go head-to-head with recently launched ETFs from Vanguard. Let’s take a peek at these compelling new offerings.

Blanket coverage of the US

First up is the iShares Core S&P U.S. Total Market (XUU), which provides exposure to the broad US stock market, including large, mid and small cap stocks.

This is iShares’ answer to the Vanguard U.S. Total Market (VUN), and it comes in five basis points cheaper, with a management fee of just 0.10%. However, the coverage is not quite as complete: VUN holds more than 3,800 stocks, compared with 1,500 for XUU. Although XUU’s benchmark is the S&P Total Market Index (which includes almost 3,900 companies) the fund actually holds three US-listed ETFs that make up the S&P Composite 1500 Index. But we should keep this in perspective: the other 2,300 companies are so small that they collectively make up just 10% of the US market,

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Rebalancing With Foreign Currencies

In my last post I argued that Canadians should avoid currency hedging in their equity portfolios. Not only does exposure to the US dollar and other foreign currencies add a layer of diversification, but hedging strategies can be imprecise and ineffective. I ended that article by encouraging investors to simply “use a rebalancing strategy to smooth out the ride.” Let’s explore that idea a little more.

The first point to understand before we go further is that you should measure your investment returns in Canadian dollars, even if some of your assets are denominated in other currencies. Indeed, you’re probably already doing that, especially if you hold US and international equities through mutual funds or Canadian-listed ETFs. The net asset value of these funds is always given in Canadian dollars, and any fluctuations in foreign exchange rates is already factored in. Even if you use US-listed ETFs, most online brokerages display the market value of your holdings in Canadian dollars, but if you’re looking at the funds’ US websites or getting quotes on Google Finance, you may be misled by returns given in US dollars.

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Stepping Back From the Hedge

We’re not quite in “northern peso” territory yet, but the Canadian dollar has taken a beating over the last couple of months. And any time there is a significant move in the markets—whether it’s stocks, interest rates or currencies—investors second-guess themselves. Of course, the financial media is always there to support them with hyperbole, overreactions and short-term thinking.

Investors might now be wondering if they should reposition their portfolios in light of the dollar’s weakness, and the subject of currency hedging inevitably arises. Let’s start with a refresher on how this strategy works.

When you hold US or international equities, you are also exposed to foreign currencies. The exchange rate between the Canadian dollar and these other currencies will affect your returns. Index funds that use currency hedging (these typically have “CAD Hedged” or “Currency Neutral” in their name) attempt to eliminate the effect of exchange rates and deliver the returns of foreign equities in their local currencies. For example, if the S&P 500 returns 10% for US investors, a currency-hedged S&P 500 should also deliver 10% in Canadian-dollar terms, regardless of whether the loonie rose or fell during the period.

A falling loonie is good for your foreign equities

I’ve received questions from investors who are worried the Canadian dollar will fall further and are wondering if they should switch to currency hedged funds for their US and international equities.

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