In a recent post, Canadian Couch Potato wondered if US-listed ETFs are really cheaper than Canadian ETFs considering that a Canadian investor incurs a 1.5 percent currency conversion charge in buying and selling a cheaper MER product. Dan constructed a model and found that:
… the US-listed ETF doesn’t take the lead until year 7 with lump sum contribution, and it takes 11 years to break even with the $5,000 annual contribution.
The fees involved in exchanging currency isn’t the only drawback to US-listed ETFs. US-listed ETFs such as the popular Vanguard VIPERs are considered US located property and might be subject to US Estate Taxes.
Despite the twin drawbacks of currency conversions and US Estate Taxes, I prefer to hold US-listed ETFs due to the following reasons:
- I fall in the camp that believes that the costs involved in currency hedging is unlikely to be a profitable strategy for a long-term investor due to the costs involved (it’s not just the higher MERs — currency hedged ETFs show terrible tracking errors). Unfortunaltely, as I mentioned in my wishlist for ETF products, currency unhedged Canadian ETFs are not currently available for the US total market and EAFE markets.
- Even in the emerging market category, the iShares MSCI Emerging Markets ETF (TSX: XEM) has a MER of 0.82%. But the Vanguard Emerging Markets ETF (VWO) is substantially cheaper at just 0.27%. All things being equal, VWO should take the lead over XEM after just 3 years assuming no growth in the investment.
- But all things are not equal. Foreign investments are best held in a RRSP account because of the harsh tax treatment meted out to foreign dividends. A US-listed ETF held in a RRSP also escapes US withholding taxes. Not so for Canadian ETFs that hold US-listed stocks or ETFs. A 2 percent dividend yield will translate into an additional 0.30 percent annual cost (at a 15 percent withholding tax rate) for a Canadian ETF holding US-listed stocks or ETFs and held in a RRSP account.
- It is true that retail investors pay a typical currency conversion charge of 1 to 1.5 percent. But as Dan points out in another post, there are ways to avoid this charge. One popular method is to ride the coattails of arbitageurs and get close to the spot rate for just the cost of two commissions. Wash trading can be employed to avoid currency conversions when selling and buying US-listed ETFs.
- And the #1 reason? As a long-term investor, I’ll be holding these ETFs for 30 years or longer. At the end of 50 years, $100,000 invested initially in a US-listed ETF will be worth 20 percent more than the Canadian ETF even after paying conversion charges of 1.5% on the initial buy, the final disposition and annual dividend payments. Those tiny MER and tax differences do make a dramatic difference for the long-term investor.
Update: Comments were not working for the past couple of days. It should be fixed now.