The following question from JS is about currency risk:
If I buy an ETF such as VEA (Vanguard Europe Pacific) through an American exchange and the US dollar falls, will my fund lose value on this basis even though the value of the Euro with respect to the US dollar might rise? In other words, does the value in Canadian dollars reflect the value of the American dollar or the international currency in the countries where the companies making up the fund reside?
While many international ETFs are denominated in US dollars and trade in a stock exchange in the US, they hold the underlying assets in the local currencies. For instance, VEA holds stocks that are traded in the UK, Japan, Continental Europe and Australia etc., which are denominated in Pounds, Yen, Euro and the Australian Dollar respectively and would be influenced by the fluctuation of the US dollar against those currencies. The result is that Canadian investors are exposed to the fluctuation between our dollar and the basket of foreign currencies. Canadian Financial DIY had written an excellent post on this topic: Clarification of Foreign Exchange Risk on International ETFs.
You can essentially ignore the CAD-USD fluctuation for broad international ETFs like Vanguard Europe Pacific ETF (VEA), iShares MSCI EAFE ETF (EFA), Vanguard Emerging Markets ETF (VWO), iShares MSCI Emerging Markets ETF (EEM) etc., country-specific ETFs like iShares MSCI Japan ETF (EWJ), iShares MSCI Australia ETF (EWA) etc. and even ADRs that trade in US exchanges but are denominated in local currencies like Nokia (NOK).
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8 responses so far ↓
1 tyler // Nov 11, 2007 at 8:54 pm
I’ve always wondered how do capital gains apply to equities bought in a foreign currency? For example, let’s say the exchange rate between CAD and USD. I take $100CAD, exchange it for $100USD, and buy some AMEX traded ETF for $100USD. One year later I sell it for $110USD but the exchange rate, let’s say, has fallen such that $110USD is only worth $100CAD. When you file your taxes can you just stipulate that your net CAD gain was zero?
Do capital gains apply to FX trades the same as they do to equities in general?
2 Canadian Capitalist // Nov 11, 2007 at 9:27 pm
tyler: You’re right. You simply convert any buy to Canadian dollars on the day you buy and convert any sell to Canadian dollars on the day you sell when reporting your taxes.
I’ve never done FX trading, so I don’t know if capital gains applies to FX trades. If there is a lot of FX transactions, I would think that they would need to be reported. Technically, if I convert $100 CAD into $100 US and sometime later convert the USD back to $110 CAD, I would think that I’d need to report a $10 gain somewhere in my taxes.
3 Phil S // Nov 12, 2007 at 8:37 am
I used to invest in a few Vanguard funds in my US brokerage account before I moved to an all-stock portfolio. The thing you need to check is whether the Vanguard fund that you selected is a hedged or un-hedged fund. They usually have two versions of every international fund they offer, one with a currency hedge, the other without. It sounds like you probably want the unhedged one to address your currency concerns.
4 CanadianInvestor // Nov 14, 2007 at 5:08 am
Thanks for the praise. These days the wild ups and downs of the Canadian $ and other currencies vs the US$ make it difficult to know where one will end up in net terms. A few days ago markets had a large drop but the C$ lost big too so I ended up a little ahead overall. Other days the market has risen but so has the loonie and I’ve lost ground. I am experiencing the noted “non-correlation” of currency and equity market returns, the diversification effect. I am worried that Peter Bernstein is correct when he says in his book Against the Gods (which I will be reviewing shortly on my blog) that “diversification is not a guarantee against loss, only against losing everything at once.”
5 Canadian Capitalist // Nov 14, 2007 at 11:14 am
CI: I’m totally unhedged and have a 50% allocation to foreign equities (US, EAFE and Emerging Markets) and the portfolio is feeling the pain of this rapid appreciation in the C$. However, I am not even contemplating changing horses now and think it’s best to stick to the original plan instead of performance chasing.
6 Sonja // Nov 16, 2007 at 2:41 pm
Hi there,
I’m just starting out in investing and your blog has been of great help to me
Forgive the newbie question, but would it be better to have index ETFs (like VTI and VEA) in RRSPs, or in a non-RRSP portfolio? I’m look at opening either a RRSP or non-RRSP Questrade account…
I know that stocks with lots of interest (and dividends when you’re in a high enough income bracket) should be in RRSPs because they’re taxed heavily. And stocks that will have capital gains should be outside RRSPs.
I plan to keep the ETFs for many years (I’m in my early 20s now).
My confusion comes from this:
Aren’t capital gains only realised when you sell? Would ETFs like VTI be counted as stock with potential capital gains or as a dividend fund (I noticed on money central that VTI *does* pay out dividends).
I’ve also read that foreign dividend funds should be in RRSPs because they don’t recieve the Canadian dividend break - does that count for ETFs like VTI?
I would prefer to leave it out of an RRSP to avoid the tax hit when I cash it in, and I don’t like the… confines of RRSPs.
thanks for any help!
7 Canadian Capitalist // Nov 17, 2007 at 2:58 pm
Hi Sonja:
In general, it is better to hold foreign equities like VTI, VEA etc. in your RRSP because in a taxable account the dividend income will be taxable at your marginal rate, as it is not eligible for the dividend tax credit. Also, money contributed to the RRSP is not taxed, so I suspect that you’ll come out ahead over the long run when you buy foreign stocks within your RRSP. Still, it would be worthwhile to run some numbers to make sure that’s the case. I’ll add this to my list of future post ideas.
8 Reader Question on EEM versus CBQ // May 13, 2008 at 11:50 pm
[...] should be protected if the foreign currency moves upward with the Canadian dollar as you mention in this post: “You can essentially ignore the CAD-USD fluctuation for broad international ETFs like [...]
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