Canadians Trading U.S. Securities (and limiting currency fees)



Canadians who wish to invest in US securities always have the issue of currency exchange to deal with.  Historically, the C$ has been below parity with the almighty greenback only having been above parity in the past few years, and in 2007.  Prior to that, you’d have to look 30 years back from then to the early-to-mid 70s, and the 50’s before that.

Source: Google Finance

Source: Google Finance

The Canadian Dollar has been in the news recently for what has been some pretty significant drops through 2013 and even to start the new year.  In just the first 10 days of 2014, the loonie has lost over 2% against George Washington and some currency analysts expect to go as low as $0.88 USD (or $1.13 CAD) over the course of this year.

Now, generally, those Canadians who are investing in US securities like the CAD to fall against the USD.  Let’s say I converted some CAD to USD in order to purchase these securities when the two currencies were on par with each other.  Well, at today’s rate of 1.0893, you’ve already made 8.9% on currency alone!  With 2013’s spectacular 29% rise in the S&P 500, Canadians received ANOTHER 8% on top of that.  On the flip side, if you bought US securities right after the financial crisis in 2008 and/or 2009, within a few months in 2009, the CAD gained almost 20% against the USD meaning your US holdings had to make at least 20% to cover the currency loss.  Now, currency tends to be somewhat stable – Canadians typically don’t experience wild +/-10% swings frequently, but there are times where it occurs.  Here are some interesting securities and transactions that have been created to help Canadians deal with currency.

Currency Hedged US-Based ETFs/Funds

Many ETF and fund providers who offer investments based on the US indices / stocks (i.e. S&P, NASDAQ, etc.) have now created currency hedged versions of these investments.  They typically hold the exact same securities, but use options/derivatives/futures to try to minimize the effect of currency allowing Canadians to partake in the return of these US indices, without worry about where the C$ is headed relative to the US$.  Vanguard has the S&P 500 Index ETF (VFV) and the S&P 500 Index ETF CAD-hedged (VSP).  Even banks are starting to get on this with TD offering a US Index Fund (TDB661) and a US Index Currency Neutral Fund (TDB655).  Typically these hedged funds cost more to manage – TD’s TDB655 has a MER (Management Expense Ratio) of .89% vs. the .55%. Thankfully Vanguard does not charge anything additional for hedging  Now, not all hedges are created equally, and it’s up to the ETF/Fund manager on how to hedge.  A quick look at how each of these did against the SPY in 2013:

Source: Google Finance

Source: Google Finance

  • The S&P (represented by SPY) ended up for the year at 29%
  • Vanguard’s US version of the S&P Index (VTI) even beat the index returning 30.85%
  • Vanguard’s Canadian S&P Version hedged (VSP) managed to fall right in between at 29.62% showing it does a pretty good job of hedging despite the 8% rise in the USD
  • Vangard’s Canadian S&P Unhedged (VFV) returned 38.92% which reflects the 8% currency gain on top of the VTI

Same goes for the TD mutual funds:

Source: Google Finance

Source: Google Finance

Unfortunately, since these funds/ETFs did not exist in 2009, I couldn’t grab the historical data to see how well the managers hedged as the CAD rose against the USD.  However, we’re not here to identify which manager currency hedges the best, but just to make folks aware that there are instruments out there that allow Canadians to invest in US based securities without having to worry about currency fluctuations.

Buying/Selling USD in Registered Accounts and “Washing”

For Canadians who want to buy individual US stocks in our registered accounts (RSP, RIF, TFSA, etc.), we also face another issue.   Most brokerages do not supporting holding USD in registered accounts.  It hasn’t been until the past couple of years that brokerages have started to support multi-currency holdings in these type of accounts with Questrade the first to offer this and with Royal the first of the big-5 to do so, followed by BMO.  Unfortunately, yours truly is with TD Direct Investing (previously known as TD Waterhouse) and while they have promised for over a year that this functionality would be available, have not been able to get their ducks in a row (been told this is a technology issue – hey, hire me to help!)

For those who like trading US securities in their registered accounts, we face a serious currency hit.  When looking up the currency rate online, we get what is known as the spot rate.  However, banks like to charge us for currency conversion fees – anywhere from 0.5% to 1.5% to their benefit.  This ends up costing us a lot in just currency in the cases where we own US stock, sell it, it gets converted to Canadian dollars for our registered account, we buy another US stock and get hit with the currency again.

Example (let’s assume 1 CAD = 1 USD for simplicity and use a 1.5% charge):

  • Own $10,000 of VTI
  • Sell $10,000 of VTI, $9850 is deposited into account (1:1 – 1.5% currency charge)
  • Buy another US security
  • Our purchase power is limited to $9704 USD because our $9850 CAD is also hit with 1.5%

So, we’ve basically lost almost 3% (~$300) on just currency fees!

Well, while these guys get their act in gear with implementing their new system, they have started to offer what is called “washing your trades”, not to be confused with laundering (unsure why the banking industry likes to use analogies with cleaning).  In my above example, if I am selling $10K worth of VTI and buying $10K worth of AIG on the same day, I simply call up the broker and say I want to wash the trade – meaning they won’t convert the sale to C$ before buying AIG.  I believe TD even does this automatically for you based on the month’s worth of trades (as I have noticed some month-end washing done in my accounts).

Washing still has some limitations – 1) it’s a hassle if you need to call the broker to wash (check with your individual broker) 2) there’s a time limit between trades to do a wash – hopefully not daily, and 3) US dividends can’t be washed.

However, TD has also introduced an automatic U.S. Dollar Money Market Sweep & Redemption Service.  I find this is a great fix to the currency issue (for me anyways) – basically all proceeds from US sells are automatically used to buy a USD Money Market fund (TDB166), which is then held until you want to buy a USD-based security.  As TD documents, you save on the currency costs and you get a better rate on the money market than holding funds directly in the account.  I was also told by the representative that this also occurs for dividends as well.

The only drawbacks is that if you won’t be able to buy Canadian securities with the US Money Market so you actually have to have cash in the account to make that purchase (or sell the USD money market first and get converted to C$).   The other drawback I’ve read about (trying to confirm personally) is TD hasn’t quite got their UI down due to trying to synchronize the settlement (stocks/ETFs settle T+3, the money market on T+1), so if you sell, you might see your account balance go down until 3 days later when it settles, and you get back the money through the MM showing up in your account.  Minor inconveniences but worth not having to pay additional fees in currency.

Norbert’s Gambit (where do they come up with these names?!)

Devised by Norbert Schlenker, Nobert’s Gambit is a great way to buy US dollars and avoiding brokerage currency fees.  It basically involves using very liquid inter-listed (available on both US and Canadian markets) securities to minimize currency exchange fees.  Basic steps are:

  • Buy the Canadian version of the security on the CAD side
  • Ask the broker to journal the trade on the USD side (resulting in you owning the US version of the security and getting pretty close to spot rate)
  • Sell the US version of the security on the US side

Originally done with liquid stocks available on both markets, thanks to ETFs, the Horizons US Dollar Currency ETF (DLR/DLR.U) appears to be the security of choice for executing this transaction.

Personally, I have not tried this, but be sure to verify cost savings based on your individual broker.  As documented by Million Dollar Journey, ETFs face no commission at Questrade – but will at other brokers – be sure to include buy and sell legs (and journal fees – although typically none) in determining overall cost.  When and how brokers do the journal to the USD account may also affect your costs – if the journal to the USD account can’t be done until the Canadian side has settled (T+3), you might already be losing more on the currency by just waiting.  Typically, you won’t see large movements in currency, but if you look at the past week, even 3 days resulting in currency going from 1.06 to 1.09 (more than the 1.5% currency fee you’d face from brokers).  This is a great idea that I might try in the near future.

So, if you are an investor in Canada who deals a lot with US securities and/or wants to have exposure to US markets without worry about currency (or reducing currency fees), try one of these methods and let me know of any other cool transactions.


4 thoughts on “Canadians Trading U.S. Securities (and limiting currency fees)

  1. It has somewhat been mentioned that hedging your ETFs to the Canadian currency in the long run is more expensive simply because the currency fluctuations cancel each other out over time. It’s better off just going without hedging if it’s possible when investing in index based ETFs so that the MERs are lower.

    If you are playing a gambit on DLR, note that the US side is fixed. This means that if you are converting from CAD to USD even the 3 day holding period will have very little effect on the currency conversion. Regardless of what happens, the price you buy DLR at is your conversion rate. When you sell DLR.U is fixed very closed to $10, so you are only paying the commissions in and out. For USD to CAD that is a different story because the DLR side will float based on the rate. If you want to fix your conversion rate, you might be able to call and verify with your broker whether they can journal and sell immediately after you buy. You’ll incur a larger brokerage fee because it’s telephone assisted, but you won’t have to wait and worry. Also I wouldn’t try this gambit unless I was trying to exchange over $5000 either way.

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