US equities
US equities are generally purchased by Canadians to provide portfolio diversification. International equities and emerging markets markets are considered in separate articles. The US stock market is the largest in the world, by far.[1]
This article first introduces typical benchmarks for US equities. It then covers currency hedging, which will impact the returns of US equities when expressed in Canadian dollars. It then mentions the main ways that individual investors can use to gain exposure to US stocks, including exchange-trade funds (ETFs), mutual funds, and stock picking.
Benchmarks
US equities are often benchmarked against the Standard and Poors 500 (S&P 500) Index,[2] which comprises 500 of the largest stocks by market capitalization that trade on US stock exchanges. The S&P 500 "captures approximately 80% coverage of available market capitalization".[3]
Other relevant indices cover the whole US market, including large-, mid-, small-, and micro-cap stocks. These "total market indices" include the S&P Total Market Index and the CRSP US Total Market Index. The latter covers "nearly 100% of the U.S. investable equity market".
The S&P 500 and total market indices, despite the different numbers of companies and market caps covered by each, have had very similar annualized returns, standard deviations, best years (return %), and worst years (return %), over several decades.[4][5]
One argument for holding index funds or index ETFs based on a total market index is that "they always hold every liquid stock on the market, including the best-performing ones".[5]
Currency hedging
Currency hedging refers to the practice of removing the effects of currency fluctuations from the returns obtained by a holding that is valued in a different currency. For example, if a Canadian investor purchased a US-based fund tracking the S&P500 (and thus valued in US dollars) and the index went up 10% but the Canadian dollar also went up 10% versus the US dollar, the currency change would cancel out the valuation change. A currency-hedged fund would, if the hedging was performed perfectly and at zero cost, cancel out the rise in the Canadian dollar, in this case enhancing the observed return. However, if the Canadian dollar were to fall, a currency-hedged fund would return less money.
Although it is possible for investors to purchase currency-hedged versions of some mutual funds and ETFs, the costs of currency hedging are a matter of some dispute. They have been estimated by portfolio manager Dan Hallett, who recommends currency hedging for those investors who wish to have the currency protection, as 0.4 to 0.5%[6] A tracking error comparison between the iShares S&P 500 Index Fund (CAD-Hedged) ETF XSP and the S&P500 is shown below.[7] This tracking error, which includes the total of the 0.24% MER, currency hedging costs, and any portfolio mismatching amounts to about 1% per year according to the BlackRocks's data:
- Note that prior to November 15, 2005, the investment objective of XSP was to replicate, to the extent possible, the performance of the S&P 500 Index. After November 15, 2005, the investment objective of XSP is to provide long-term capital growth by replicating, to the extent possible, the performance of the S&P 500 Hedged to Canadian Dollars.[8]
Another tracking error chart can be obtained from BigCharts,[9], and is shown below. This chart suggests an error of about 2% per year:
An up-to-date version of the BigCharts graph can be obtained in
this link. Although the two graphs disagree significantly in the size of the total tracking error, it is nevertheless clear that currency hedging will add significant costs above the 0.24% MER.
It should also be noted that investors who face significant US-dollar expenses - say, for "snowbirding" in the US - may not wish to hedge so that the currencies of their investments better match the currencies of their expenses.
A classic argument in favour or currency hedging it that it lowers volatility, but this is apparently not true for Canadians purchasing foreign stocks [10]
Mutual funds and exchange-traded funds
Mutual funds
Many actively managed Canadian mutual funds are available that allow Canadians to purchase US equities. Passively managed index funds are also available. A notable index fund for self-managed investors is the TD U.S. Index Fund - e, Fund Code TDB902.
For investors using an advisor and paying fees to them directly, the RBC U.S. Equity Index ETF Fund (RBF2143) is a F-series mutual fund, with a MER of 0.15%, which contains nearly 100% iShares Core S&P 500 ETF.
S&P500 ETFs
Many S&P500 exchange-traded funds (ETFs) are available, both on Canadian and US exchanges. Those trading on US exchanges are interesting for RRSPs and similar accounts, since the foreign withholding taxes can be avoided this way (see tax-efficient investing). For other types of accounts, like TFSAs and non-registered accounts, ETFs trading on Canadian exchanges avoid currency conversion issues. See Canadian- vs US-listed ETFs for a general comparison.
Notable products include:
Canadian exchanges, unhedged:
- Vanguard S&P 500 Index ETF (VFV)
- iShares Core S&P 500 Index ETF (XUS)
- BMO S&P 500 Index ETF (ZSP)
- CAD-hedged versions are also available
US exchanges:
Total US market ETFs
As with S&P500 ETFs, US-listed total US market ETFs can make sense for RRSPs, whereas Canadian-listed ETFs can be preferable for other types of accounts.
Canadian exchanges, unhedged:
- Vanguard U.S. Total Market Index ETF (VUN)
- iShares Core S&P U.S. Total Market Index ETF (XUU)
- CAD-hedged versions are also available
US exchanges:
US stocks
US stocks can also be purchased directly by Canadian investors who wish to practice their own stock selection.
See also
References
- ^ All of the World’s Stock Exchanges by Size, February 17, 2016, viewed January 4, 2020.
- ^ Wikipedia, S&P 500, viewed March 12, 2009.
- ^ S&P 500® - S&P Dow Jones Indices, viewed October 2, 2021.
- ^ VOO vs. VTI – Vanguard’s S&P 500 and Total Stock Market ETFs, updated September 14, 2021, viewed October 2, 2021.
- ^ a b Raymond Kerzérho, US Total Market or S&P 500 ETFs?, August 24, 2023, viewed October 26, 2023.
- ^ Rob Carrick, The pluses - and minuses - of currency hedging, Globe and Mail, June 6, 2009. Viewed August 15, 2009.
- ^ BlackRock Asset Management Canada Limited, Tracking Error Charting Tool, XSP, viewed January 16, 2012.
- ^ XSP - iShares S&P 500 Index Fund (CAD-Hedged) Annual MRFP, viewed January 16, 2012
- ^ BigCharts, plot of CA:XSP versus S&P500, viewed January 17, 2012
- ^ Canadian Couch Potato, Why Currency Hedging Doesn’t Work in Canada, viewed Dec. 27, 2014
External links
- Canadian Portfolio Manager Blog, Understanding US Equity ETFs, February 2019
- Understanding US Equity ETFs, a video from Justin Bender
