Any currency volatility can send investors hunting for hedged ETFs. But the extra costs limit the appeal of currency hedging.
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.
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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.
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.
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 a loss.
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.
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
ISHARES 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.
Among the highest-weighted stocks for the ETF are Apple, Tesla, Microsoft, Facebook, Johnson & Johnson, JPMorgan Chase, Amazon.com, Alphabet,, Berkshire Hathaway and Nvidia.
Expenses on the units are 0.10% of assets, excluding the cost of currency hedging. Those hedges add costs of 0.13% to the units, for a total of 0.23%. That’s more than double the 0.10% MER on the unhedged iShares Core S&P 500 Index ETF, symbol XUS on Toronto.
TSI Network recommendation: 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 ETF is okay to hold.
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.