Any currency volatility can send investors hunting for hedged ETFs. But the extra costs limit the appeal of currency hedging as a strategy.
If you want to buy U.S. stocks and hedge against the U.S. dollar’s movements against the Canadian dollar, you could buy a hedged ETF like the iShares Core S&P 500 ETF.
Hedged ETFs like the iShares Core S&P 500 ETF are funds sold in Canada that hold U.S. stocks. However, they are hedged against any movement of the U.S. dollar against the Canadian dollar. That means that the ETF’s Canadian-dollar value rises and falls solely with the movements of the stocks in the portfolio. The choice between CAD hedged vs unhedged ETFs is an important consideration for Canadian investors.
For example, if a stock rises 10% on, say, New York, but also rises a further 5% for Canadian investors due to an increase in the U.S. dollar, a holder of a hedged ETF would only see a 10% rise in the value of that holding in their hedged ETF. At the same time, the reverse is also true: If a stock rises 10% on New York, but falls 5% for Canadian investors due to a decrease in the U.S. dollar, a holder of a hedged ETF would still see a 10% rise in the value of that holding as part of their hedged ETF. Understanding the implications of cad hedged vs unhedged exposure is crucial.
Hedged funds include extra fees to pay for the hedging contracts needed to factor out currency movements. Of course, those costs can rise or fall regardless of currency swings. When comparing cad hedged vs unhedged ETFs, these additional fees should be taken into account.
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Hedging against changes in the U.S. dollar only works in your favour when the value of the U.S. dollar drops in relation to the Canadian currency. If the U.S. dollar rises while your investment is hedged, it reduces any gain you’d otherwise enjoy, or expands any loss. This is a key risk to consider in the CAD hedged vs unhedged decision.
Even in today’s market, some investors have mixed feelings today about investing in U.S. indexes such as the S&P 500. They may have a high opinion of many of the major multinational companies in the S&P 500. But they may also fear the U.S. dollar has gone too high in the past few years and is at risk of a downturn. So hedged ETFs may have some appeal. Examining cad hedged vs unhedged returns over various timeframes can help inform this perspective.
However, we see U.S.-dollar exposure as a long-term plus—a valuable form of diversification. If you are worried about the possibility of a U.S. dollar decline, our advice is to reduce your exposure to U.S. stocks and other U.S. dollar assets. There are no bargains in the market for foreign-currency hedging.
We don’t recommend hedged ETFs. But here’s a look at the prominent iShares Core S&P 500 ETF:
ETFs: Hedges add 0.13% to unit costs
Shares Core S&P 500 Index ETF (CAD-Hedged), symbol XSP on Toronto, holds the stocks in the S&P 500 Index. This index is comprised of 500 major U.S. stocks chosen for market size, liquidity, and industry group representation.
The index’s highest-weighted stocks include Apple; Microsoft; Alphabet; Amazon.com; Tesla; Berkshire Hathaway; UnitedHealth Group; Exxon Mobil; and Johnson & Johnson.
Expenses on the units are a low 0.09% of assets, excluding the cost of currency hedges. Those hedges add costs of roughly 0.13% to the units, for a total expense ratio of 0.22%. That’s more than double the 0.095% MER on the unhedged SPDR S&P 500 ETF, symbol SPY on New York.
If you feel you must own a U.S. index fund hedged against a drop in the U.S. dollar, the iShares Core S&P 500 Index ETF (CAD-Hedged) is okay to hold.
However, we see the SPDR S&P 500 ETF as a buy.
In summary, for Canadian investors considering exposure to U.S. equities, the decision between currency-hedged and unhedged ETFs is important. Hedged ETFs like the iShares Core S&P 500 ETF (CAD-Hedged) protect against fluctuations in the USD/CAD exchange rate, ensuring returns reflect only the underlying stock performance. However, this hedging comes with additional costs and can limit gains if the U.S. dollar appreciates. Unhedged ETFs like the SPDR S&P 500 ETF offer cheaper access to the same stocks but introduce currency risk. Ultimately, the choice depends on an investor’s view of the U.S. dollar’s future direction and their desire for diversification. While hedged ETFs may appeal to those fearing a U.S. dollar decline, we see long-term benefits in maintaining unhedged U.S. exposure and suggest reducing allocation to U.S. assets if you’re concerned about currency risk. We recommend the unhedged SPDR S&P 500 ETF as a “buy,” while considering the iShares Core S&P 500 Index ETF (CAD-Hedged) as merely “okay to hold” for those insistent on hedging.
For our views on getting the greatest impact from your investments in ETFs, read What are ETFs? A guide to investing in exchange traded funds.
For our recent report on ETFs that offer a better way to invest in bonds, read These bond funds offer top-quality holdings.
This post was originally published in November 2018 and is regularly updated.
