Exchange-traded fund providers have been rolling out more U.S.-dollar denominated products in recent weeks to help investors reduce potential currency volatility amid a rising interest-rate environment in both Canada and the U.S.
Toronto-Dominion Bank recently launched five U.S.-dollar denominated ETFs in areas such as general equities, health care, technology and a couple of dividend-focused products, while the Bank of Montreal put out a trio of new funds aimed at Canadians with U.S. dollars to invest, bringing its stable of U.S. currency funds to 20. The new BMO U.S. dollar-denominated funds include a version of its monthly income, covered call banks and laddered preferred share index ETFs.
BMO’s new ETFs are aimed at investors “dealing in U.S. dollars for whatever reason – whether that is snowbirds or people with private companies or just travellers in general,” says Mark Raes, head of product ETFs and mutual funds at BMO Global Asset Management.
“It’s a convenience tool for Canadians that have U.S. dollars that they need to invest,” he says, adding that demand has snowballed. “By just having a few of these, people are asking for more.”
Evolve Funds Group Inc. also recently launched its Evolve European Banks Enhanced Yield ETF, which features Canadian dollar hedged and unhedged versions and a U.S. dollar unhedged fund.
Daniel Straus, director of ETFs and financial products research with National Bank Financial, says it has been about a decade since Canada saw so many U.S.-dollar denominated ETF launches – when the Canadian dollar was at par with the U.S. currency.
He says there was a strong consensus on the Street at the time that the U.S. dollar was about to embark on an extended run against the Canadian dollar. While that turned out to be the case, Mr. Straus isn’t making any currency predictions today.
It’s relatively easy for a provider to roll a U.S. currency ETF alongside a non-currency hedged Canadian dollar ETF, Mr. Straus says.
“They run effectively identical portfolios,” he says.
For most ETF investors, the Canadian-dollar denominated fund that doesn’t have a currency hedge will provide the same exposure as the U.S. dollar version, Mr. Straus notes.
He says U.S.-dollar denominated ETFs traded in Canada are attractive to high-net-worth Canadian investors with large holdings of U.S. assets such as real estate and securities that could be subject to U.S. estate taxes.
“A Canadian trust denominated in U.S. dollars lets such investors maintain their U.S.-dollar holdings without subjecting their dependents to this potential tax liability,” Mr. Straus adds.
Rising interest rates and the need to keep institutional investors happy are also putting a renewed emphasis on U.S.-denominated ETFs, says Mark Noble, executive vice-president of ETF Strategy with Toronto-based Horizons ETFs Management (Canada).
“Currency volatility is likely to be higher this year, with both Canada and the U.S. expected to raise interest rates more than four times,” he says.
For popular funds, ETF issuers typically offer investors a third currency choice – a Canadian-dollar hedged version that typically attempts to eliminate the movement of the U.S. dollar against the loonie.
“The currency component for ETFs is, unfortunately for Canadians, a big decision,” Mr. Noble says. “You can get the equity class or sector class right and you can still lose 5 or 6 per cent by getting the currency call wrong.”
Still, Mr. Noble warns that a hedge is a drag on fund returns, costing between 20 and 30 basis points per year to run a currency strategy, primarily because of expenses related to placing forward contracts to cover future currency fluctuations.
Unless investors are placing shorter-term bets (months to one-to-two years), he argues that unhedged investing is the way to go for Canadians, particularly with regard to American investments.
If U.S. equities are rising, likely the U.S. economy is improving as well as the U.S. greenback relative to other currencies, so hedging is unnecessary.
In addition, he notes that only the U.S. dollar and Swiss franc seem to trade in parallel, with all the other currencies lumped into the “other” category trading inversely to the U.S. dollar so exposure should be welcomed rather than avoided.
Having exposure to the U.S. with unhedged funds “is a huge source of diversification and differentiation of return,” he says.