Archive | Foreign currency

Ask the Spud: The US-Dollar Couch Potato

We just sold our condo in Florida and now have some money to invest in non-registered accounts. The problem is, the money is all in American dollars. Is there a way to use the Couch Potato strategy using only USD? – John D.

It’s certainly possible to build a fully diversified ETF portfolio using only US dollars, but there are a number of important issues to consider.

The first is whether you really need to keep the money in USD. If you don’t plan to make another major purchase in the United States (or if you earn a lot of USD income but all your expenses are in Canadian dollars) it might make sense to exchange most or all the money into your home currency before investing it. Of course, you will need to find a low-cost method for doing this, such as Norbert’s gambit.

You also need to consider your overall asset location. Holding fixed income, Canadian equities, and foreign equities in a non-registered USD account probably isn’t the most tax-efficient strategy. Even if your registered accounts are maxed out, you can still make changes so your fixed income stays in Canadian dollars in RRSPs and TFSAs,

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Calculating Foreign Returns in Canadian Dollars

Global diversification was a huge benefit to investors in 2012, as Canadian equities lagged well behind the rest of the world. Two core funds in the Complete Couch Potato are the Vanguard Total Stock Market (VTI) and the Vanguard Total International Stock (VXUS), and last year these funds delivered returns of 16.40% and 18.22% respectively.

But these figures are misleading, because they’re expressed in US dollars. A Canadian investor is likely to be more concerned about how their US-listed ETFs performed in terms of our own currency. And that information isn’t easily available, so you need to do the math yourself. It’s a two-step process:

1. Determine the annual change in the exchange rate. Your first step is to learn how much the value of $1 USD changed over the year. That means looking up the exchange rates on December 31 of both 2011 and 2012. There are several sources for these data, but I’ve used XE.com. If you use another (such as the Bank of Canada or OANDA) you’re sure to get slightly different numbers: there are noon rates, closing rates,

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How Much Are You Paying For US Dollars?

Currency conversion remains one of the biggest rip-offs in banking and investing. It’s made worse by the lack of transparency: if you call your discount brokerage they’ll quote their current rates, but it’s still hard to calculate the actual cost of your transaction. Don’t expect your brokerage to help with the math.

The first key point is, in practical terms, there isn’t a single exchange rate. While we might say “the US and Canadian dollars are at par,” that’s never quite true. On a day when the two currencies are theoretically equivalent, it might cost you $1.01 CAD to buy $1 USD, and if you sell $1 USD you might receive $0.99 CAD. That’s because currencies have a bid-ask spread just like stocks and ETFs that trade on an exchange.

There’s a simple formula to calculate the size of the bid-ask spread in percentage terms:

= (Ask Price – Bid Price) ÷ Ask Price × 100

Note that the bid price is always the lowest of the two rates you’re quoted. So if we plug in the numbers in the example above, the math works like this:

= (1.01 – 0.99) ÷ 1.01 × 100
= (0.02) ÷ 1.01 × 100
= 0.0198 × 100
= 1.98%

The bid-ask spread in this example works out to 1.98%,

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Ask the Spud: Should I Hold US Bonds?

Q: One of my coworkers and I recently started our own Couch Potato portfolios and we’re wondering if it would be better to have some American bonds in the mix. Wouldn’t that be another way to diversify? – Jason L.

The answer depends on whether you’re talking about government bonds or corporate bonds.

It’s usually not a good idea for Canadians to hold US or other foreign government bonds in their portfolio. In theory, because interest rates are not the same in every country, it can makes sense to diversify your bond holdings globally. However, investing in US or international bonds exposes Canadians to currency risk.

Currency risk is welcome on the equity side of your portfolio, because it can lower volatility without decreasing expected returns. That’s why I recommend using unhedged index funds and ETFs for US and international stocks. But the situation is different for fixed income. The yield differential between Canadian and US bonds is likely to be quite small, and it will be completely overwhelmed by significant changes in the exchange rate. That means adding currency risk to your bond holdings will tend to increase volatility without increasing expected returns.

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A New Way to Sidestep Currency Conversion Costs

One of my biggest frustrations as an ETF investor is that so few online brokerages allow you to hold US dollars in registered accounts. Last year BMO InvestorLine became just the fourth brokerage to add this feature, following RBC Direct Investing, Questrade and Qtrade.

A few other brokerages offer partial solutions: TD Waterhouse, for example, allows you wash your trade if you’re selling one US security and buying another in an RRSP. But that doesn’t help you if you have new US dollars your want to contribute to your registered accounts.

My own brokerage, Scotia iTrade, offers a so-called US-Friendly RRSP. For a flat fee of $30 per quarter, you can buy US securities in your RRSP with Canadian dollars and avoid the usual spread, which is about 1.5%. I test-drove this service last year, and it’s adequate if you’re making a large transaction once a year. But I’m not going to pay $120 annually for it. Especially now that I’ve discovered a solution for sidestepping currency exchange fees in RRSPs—a solution that should work at any brokerage.

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Claymore’s CGL: When Buying Gold Isn’t Enough

In Monday’s post, I answered a reader’s question about the iShares Gold Trust, an ETF that is cross-listed on the Toronto and New York Stock Exchanges with the ticker symbols IGT and IAU, respectively. I explained that while it is possible to buy and sell this product in either US or Canadian dollars, neither version gives you any exposure to currency risk. However, that’s not the case with the Claymore Gold Bullion ETF (CGL), which also tracks the price of the yellow metal by holding gold bullion. CGL is unique among gold ETFs in that it uses currency hedging.

It’s worth pausing to think about this concept. As most index investors know, it’s common for funds that hold foreign stocks or bonds to hedge their currency exposure to protect Canadians from the effects of a rising loonie. But gold is not a foreign-denominated asset, like shares in Coca-Cola. Yes, its price is widely quoted in US dollars, but that’s not the same thing. Think about it this way: if you were buying gold bullion from the Royal Canadian Mint,

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Ask the Spud: iShares Gold Trust

Q: The iShares Gold Trust (IGT) trades on the Toronto Stock Exchange, but I can’t find it on the iShares Canada website. Can you tell me why? — Jim O.

The iShares Comex Gold Trust is an exchange-traded product that tracks the price of gold. Like its competitor, SPDR Gold Shares (GLD), the trust is backed by gold bullion held in a vault by a custodian.

But although IGT is listed on the Toronto Stock Exchange, it is not a Canadian product. It’s simply a cross-listing of the iShares Gold Trust (IAU), which is domiciled in the US and traded on the NYSE. That’s why it isn’t included on the iShares Canada site.

If you’re not familiar with cross-listing, it’s a common practice among large corporations that want their shares to trade in more than one currency (and sometimes more than one time zone). For example, while Research in Motion is a Canadian company traded on the TSX, you can also buy its shares in US dollars on the NASDAQ. There are many other examples of companies with dual listings,

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Review: Scotia iTrade’s US-Friendly RRSP

The cost of investing has dropped dramatically since the advent of online discount brokerages, but there are a couple of transactions where Joe Retail stills get clobbered. One of these is currency exchange fees: charging clients 1.5% or more to convert Canadian dollars to US dollars—and the same to change them back—is a disgrace. Investors who use US-listed ETFs need to find ways to avoid foreign exchange fees or they risk giving back everything they save on the lower management fees.

As a client of Scotia iTrade, I had an opportunity to test-drive their US-Friendly RRSP program this month as I made some changes in my portfolio. I used to hold three separate ETFs for my international equities, but when the Vanguard Total International Stock (VXUS) was launched earlier this year, it made sense for me to merge them into a single fund when I next rebalanced. So I was in a position to sell three US-listed ETFs and buy another, and these four trades would have cost me hundreds of dollars in foreign exchange fees at the usual rate.

However, Scotia iTrade’s US-Friendly RRSP offered a solution.

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Why Do Index Funds Use Derivatives?

Earlier this week I described how several US and international equity index funds get their market exposure by using index futures rather than holding the stocks directly. This structure is partly a holdover from the days when Canadians could keep only a small portion of their RRSPs in foreign investments. But the question remains: now that foreign content rules are long gone, why don’t these funds just move to a traditional structure and buy all the stocks in the index?

I put that question to Paul Mayhew, RBC Global Asset Management’s VP of Research and Product Development. He explained that the non-hedged version of the US Index Fund actually does hold all the stocks in the S&P 500. However, RBC decided to continue with the old structure in the US and international index funds that use currency hedging, because futures contracts provide an easy way to manage the foreign exchange risk. More important, however, was the potential tax advantage of keeping the derivative structure intact.

Their loss is your gain

This is actually pretty counterintuitive. Funds that use index futures are not normally tax-efficient, because any gains are treated as interest income,

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