I passed along reader questions received in an earlier post on Claymore Broad Emerging Markets ETF (CWO) to Som Seif, President of Claymore Investments. Here’s his response:

  1. Currently, 100% of CWO’s holding is the Vanguard Emerging Markets ETF (VWO). Does CWO plan to hold emerging market stocks directly in the future? If CWO does plan to hold 100% in VWO, is that the reason why the precise benchmark that is tracked is vague in the factsheet?

    SS: The benchmark is the MSCI Emerging Markets index. We left [it] open in filing prospectus as we were working to sort out which index we were going to bring. We do plan on holding VWO for now; it’s a good way to execute as the fund is smaller. Over time, we may add individual securities.

  2. The fact sheet mentions that CWO hedges the currency exposure but it is unclear which currency fluctuation is hedged? Is the hedge on CAD/USD fluctuations or CAD/Emerging market currency fluctuations?

    SS: We are hedging the currency currently of the USD/CAD. But this is because the USD hedge is a very strong proxy hedge to the individual currencies of the emerging countries. If you factor in the cost of hedging (spread, interest rates) each of the individual countries, hedging the USD is the best way to proxy hedge. Over time, as the size of assets increase, we may start to hedge some of the individual currencies, but again, USD is likely just as strong (correlation of USD hedged vs. local MSCI Emerging markets index is very high).

  3. Related to (2), why does the Claymore BRIC ETF (CBQ) hedge the CAD/USD exposure while still is exposed to the USD/Emerging market currency fluctuations? Why does it make sense for Canadian investors to take on USD/Emerging markets currency risk but avoid the CAD/Emerging markets currency risk?

    SS: Same as (2). One thing that is REALLY important, I think gets lost by many individual investors (when I read the blogs) is they don’t consider the FX trading costs of buying US traded ETFs. I think it needs to be better understood. Example: A US Vanguard ETF, say 10 bps MER, looks very low cost, but for a Canadian, it is actually quite expensive.

    If you buy US ETF, pay 1-1.5% FX exchange rate on trades (i.e. $10,000 CAD buying $8,000 USD, spread of spot FX versus what bank/discount broker charges). If you hold ETF for 2 yrs, and then sell again, with 1-1.5% FX cost.

    All in cost = 1% + 0.2% + 1% = 2.2%/2 yrs = 1.1% MER per annum… this is much different than Canadian traded ETFs. And FYI, the shorter the hold, the more expensive this is.

    This needs to be understood. People compare buying a Canadian traded ETF vs. buying a US traded ETF directly by their MER differences. But in fact, it’s the smallest difference. Wherever possible, they should always trade CAD traded ETFs before they buy US traded ETFs.

This article has 20 comments

  1. If they want me to “trade” CAD ETFs, they’re going to have to give me a full slate of unhedged products to work with. Part of the diversification benefit of investing overseas is exposure to currency risk. IMHO, hedging foreign equity holdings back into CAD is expensive and detrimental.

    The example he gives, of a trade into USD, buy, then sell and trade back into CAD is self serving at best, disingenuous at worst. How does this look if the holding period of the USD ETF is 10 years? Or 20 or 30 years? 50 basis points a year in higher cost for the privilege of holding the product in CAD doesn’t take many years to eat the forex costs. Does Claymore represent that their forex costs are zero? They can do these transactions with a smaller spread that a retail investor, but there is still a forex cost embedded in their MER.

    Also conveniently ignored is the bid/ask spread. As of 11:20am on June 3rd:
    Bid/ask spread of CWO 0.36% (10 cent spread)
    Bid/ask spread of VWO 0.03% (1 cent spread)

    So a round-trip trade of CWO costs 72 basis points, whereas a round trip trade of VWO costs 6 basis points. There’s not a lot Claymore can do about that, given VWO ‘s average volume is 600 times CWO’s, but it’s a cost that Claymore conveniently ignores.

    Overall, CWO seems like a very expensive way to do what I’m already doing at much lower cost. Just one happy VWO holder’s opinion.

  2. Canadian Capitalist

    Matt: I raised the same points in my reply to Som, which I’ll be posting in the near future. I’m a happy holder of VWO as well. Here are the points that work in VWO’s favour:

    1. No hedging. I’ve written posts in the past on how bad tracking errors of these hedged ETFs are. I think there is plenty of strong evidence that hedging might just not be worth the cost. I’ve read estimates that hedging costs 1% per year (these costs are not reflected in the MER), which may be a huge hurdle to just break even with hedging.

    2. Canadian Financial DIY raised questions on whether a CAD/USD is really a proxy for CAD/Emerging Markets currency fluctuations. http://canadianfinancialdiy.blogspot.com/2009/05/claymores-emerging-markets-etf-tsxcwo.html

    3. You’ve raised the points about bid/ask spreads. Low volume ETFs are a significant risk for long-term investors. What if Claymore decided CWO isn’t profitable enough and shuts it down.

    4. CWO has additional withholding tax drag when held in a RRSP. VWO pays a withholding tax to the respective countries it holds. CWO pays a 15% withholding tax to IRS that is not recoverable when held within a RRSP. Assuming VWO’s yield is 3%, withholding tax alone adds 45 basis points to the CWO cost.

    5. I agree that the example provided here is a bit self-serving. Why would an investor want to hold VWO for just 2 years? Personally, my VWO holding period is 20 years or more. And I think, investors should buy VWO only if they intend to hold it for the long-term. We all know how well short-term trading works out for most investors.

    The only advantage I can see for ETFs like CWO is US Estate Tax implications. The higher cost might be acceptable for high networth investors. But then again, I’d personally want an unhedged ETF.

    Unfortunately, those of us who are fans of unhedged funds are screwed. I can’t think of a single ETF in Canada that is not hedged. It applies to iShares, Claymore and even prospective ETFs from BMO.

  3. Dave in Kanata

    Hi Matt (and others),

    Please ‘dumb it down’ for me. When I invest in ETF’s, my preference would be to have 0 currency risk. The problem is that I find that all non-North American ETFs are ony available in $US or $CDN since they are traded on either the Canadian or American markets. So, any Emerging Markey, European, Asian, etc… ETFs are mostly in $US with a few $CDN hedged ones. So, my choice is to expose myself to a huge $US currency risk or hedge it to $CDN and pay the extra MER. My thinking, thus far, has been to accept the higher MER so I have no currency risk since when I retire (RSP) or withdraw from my RESP, I will need Canadian dollars. This is especially important given all the money the US gov’t is printing to bail everyone out.

    Am I missing something? That is, are some of my assumptions not valid. Please Keep It Simple.

    • Canadian Capitalist

      Dave: ETFs trading in US exchanges that in turn hold foreign stocks do not expose you to CAD/USD fluctuations. Let’s take a simple example. Say, you have a Japanese ADR that is equal to one Japanese stock trading at 1,000 Yen. If the USD/Yen exchange rate is 1 USD = 100 Yen, all things being equal, the ADR will be trading at $10 US.

      Now assume a Canadian investor buys that Japanese ADR. 1 CAD = 1 USD = 100 Yen. So it costs $10 CAD for our Canadian investor.

      Fast forward one year. Stock is still trading at 1000 Yen but 1 USD = 90 Yen and 1 USD = 1.25 CAD. i.e. USD depreciated against the Yen but appreciated against the CAD. The ADR will trade at $11.11 US but it is worth $13.89 CAD.

      So here’s how it works out for a Canadian investor:
      CAD depreciated 20% against the USD.
      USD depreciated 10% against the Yen.
      CAD depreciated 28% against the Yen.

      For a Canadian investor the Japanese ADR appreciated by 38.89%, which is exactly the amount by which the Yen appreciated against the CAD (1/0.72). The reason is the CAD/USD fluctuation is overlaid on the USD/Yen fluctuation leaving a Canadian investor with just the CAD/Yen fluctuation.

      In other words, the currency fluctuations a Canadian investor is exposed to for a foreign stock (or ETF) traded in an US exchange (that does not hedge its currency fluctuations) is not the CAD/USD rate. Instead, it is the CAD to whatever the currency the security is denominated in.

  4. Som’s answer 3. in the original post is valid if the ETF is only held for 2 years or similar but this cost diminishes the longer the ETF is held.

  5. Dave:

    Taking VWO as example, it doesn’t matter that it is traded in USD because the actual underlying stocks are held in other currencies. If the USD goes down the toilet and all else stays the same, the value of a VWO share in USD would skyrocket…. but stay the same in CAD or any other currency.


  6. Dave in Kanata

    OK, I think I get it. So, what you are saying is that over some timeframe, there should be no difference (excluding MER differences) in performance if I had $CDN 100 and bought XIN.TO (iShares EAFA Index hedged CDN/US) or EFA (iShares EAFA in $US) no matter what happened to the US and CDN currencies, right? At the end of the timeframe, the value of either ETF in $CDN will be the same.

    Isn’t it possible that the $CDN appreciates considerably against the $US but not with repect to other currencies?

    I am actually going to try this out myself on XIN.TO and EAF over different times (not that I don’t believe you 🙂 )

    Thanks again.

    • Canadian Capitalist

      Actually no. XIN.TO, if memory serves right, holds EFA and hedges the CAD/basket of currencies. So XIN.TO is designed to provide returns that local investors in the respective EAFE countries would earn in their respective currencies less any hedging expenses. EFA will provide EAFE returns in CAD for a Canadian investor who holds it directly. So, I’d expect XIN.TO and EFA to have different returns over any time frame.

      If XIN.TO had held EAFE stocks directly and didn’t do hedging, then such a XIN.TO and EFA will return the same in CAD terms for a Canadian investor.

  7. Charles in Vancouver

    “the USD hedge is a very strong proxy hedge to the individual currencies of the emerging countries…”

    I think this is total bull, especially having seen Canadian Financial DIY’s chart. If his statment is correct, then it suggests US investors are exposed to very weak or no currency risk when they invest in emerging markets with US dollars. Is this true??

    (Granted, American investors aren’t exposed to such a barrage of funds that hedge currency risk, but they must know it exists.)

  8. Dave in Kanata

    OK, I’ve run some quick calculations and my numbers do not line up with what you are saying.

    Here is the data from Yahoo:

    EFA($US) Jan 2006 = 59.27; Jan 2007 = 71.48
    XIN.TO($CDN) Jan 2006 = 23.27; Jan 2007 = 26.89
    1 $US to $CDN Jan 2006 = 1.1629; Jan 2007 = 0.9931

    So, if I buy $CDN 100 of both in Jan 2006, I end up with 1.451 shares of EFA and 4.297 shares of XIN. In Jan 2007, if I sell both, I end up with $CDN 103.0 for my EFA shares and $CDN 115.6 for my XIN shares. I verified my calculations and they look good. I also verified that the XIN.TO values are in Canadian Dollars.

    Where did I go wrong???

    • Canadian Capitalist

      Dave: See my previous comment. EFA returns are not directly comparable to XIN.TO returns because XIN.TO holds EFA and hedges the CAD/EAFE currency basket exposure.

      The USD rate for Jan 2007 is incorrect in your calculation. It is 1.1653. So, you’ll have $120.86CAD worth of EFA shares for a 20% price return in 2006. Add in the dividend and you are looking at something close to the 25.5% that the TD e-Series International Index reported in 2006.

  9. Dave, using your numbers, during that time frame the Canadian dollar rose about 15% against the USD. If you had purchased XIN.TO, which hedged it’s results back into CAD, then you got the updraft of the Canadian dollar rising.

    XIN.TO will outperform EFA when the Canadian dollar rises against USD, and EFA will outperform if the Canadian dollar falls against the USD. That’s because all XIN.TO is is EFA with a hedge to CAD.

  10. Terry from Calgary

    As part of my asset allocation strategy, I have US equities. I buy these holdings in Canadian dollars and then transfer them to US dollar based account. This is done at TD Waterhouse with a simple phone call. I can then trade these equities with other US equities and not pay the spread on the buy FX exchange. Upon retirement, sometime in the future, assuming I retire in Canada, I’ll have to pay the spread on the sell FX exchange rate. This is how I minimize and buy/sell FX spreads.

  11. @ Terry, Is this a non-registered account? I think it is. Right now only Questrade allows customers to hold USD in their registered accounts. However, it is only a matter of time before other brokers follow suit and allow customers to directly hold USD in their RSPs. This would make holding VEA (instead of XIN) and VWO (instead of CWO) even more attractive. Still, I’m not comfortable having all of my international and emerging markets exposure in USD so I split it 60% for the USD ETFs and 40% for the CAD ones.

  12. How are low-volume ETFs a significant risk for a long-term investor? If Claymore decides to close this fund, what exactly would that entail for the money of those invested?

  13. Terry from Calgary

    DM, yes only in non-registered.

  14. Canadian Capitalist

    @DM, @Terry: Actually, some brokerages will even allow you to wash your trades in a *registered account*. I’ve written about it in the past:


    Search for “wash trades” as many brokers in addition to TD Waterhouse offer this now.

  15. Re. point 3, if you are paying 1-1.5% for currency exchange with your broker, you need another broker ASAP. I’m not going to bother shilling for any specific brokers, but much better rates are available.

  16. Pingback: Weekend Reading - June 5, 2009 | Million Dollar Journey

  17. MJ-
    Re. point 3, if you are paying 1-1.5% for currency exchange with your broker, you need another broker ASAP. I’m not going to bother shilling for any specific brokers, but much better rates are available.

    Hey, thanks to this site I learned of Norbert’s Gambit… which is a method of achieving a foreign exchange at minimal cost (Google it).