Thoughts in Response to Rob Carrick’s “Why Canadian investors should stop buying U.S.-listed ETFs”

On February 4, 2021, Rob Carrick, the well-known personal finance columnist at The Globe and Mail, published an article entitled, “Why Canadian investors should stop buying U.S.-listed ETFs.” I tend to agree with Carrick on this point, but his argument is boiled down to two reasons: 1. the competitive MERs now offered by Canadian-listed ETFs that track U.S. indices; and 2. the narrow exchange rate spreads available to the ETF companies that are not available to retail level investors. Both these reasons are valid, but I would like to dig into U.S.-listed ETFs just a bit more and offer a few more observations on why one might or might not choose a U.S.-listed ETF.


MER Comparison

In recent years, there has been a price war among ETF providers that has tended to drive down the expenses charged by the ETF providers. This is especially the case for the ETFs offered by the major players that track broad-market indices. You can certainly find a much wider variety of ETFs out there, similar to the way that mutual funds have proliferated when they became a fixture for investing in the 1980s, but for the purposes of this post, I am not going to delve into those “weeds.”


Below is a small table of the most widely held ETFs with among the lowest MERs available.



Both XUU and VTI seek total exposure to the U.S.-listed stock markets, including stock from mid-sized and smaller companies. They both hold shares of about 3600 different companies. By contrast, ZSP and SPY track the S&P 500 stock index which focuses on 500 of the largest companies in the United States. To be clear, though, all four of these ETFs hold the underlying shares on a “cap-weighted” basis, meaning that the shares of each company held have an impact on the price of the ETF in proportion to their relative size. In other words, even though XUU and VTI hold the shares of many more companies, the impact of the price movement of the smaller companies is not nearly as significant as the effect of the movement of a larger company. Having said that, if a smaller company grows rapidly it will begin to exert an increasingly important effect on XUU and VTI compared to ZSP or SPY, which will not be impacted until that growing smaller company is added to the S&P 500 index.


You can see that all four of these ETFs have very low MERs, a far cry from the 1.7 to 2.3 percent you might pay for the average actively managed U.S. equity mutual fund.


Foreign Exchange Rates

Carrick points out that buying U.S.-listed ETFs inevitably involves going through a foreign-exchange process. This would typically happen in one of two ways. You could take some of your Canadian dollars and transfer it over to the U.S. dollar side of your account, which I believe is available in almost all brokerages these days. The other approach would be to buy the U.S.-listed ETF in the Canadian dollar side and then transfer it over to the U.S. dollar side afterward. The foreign exchange process would have taken place by the broker as they processed your buy order.


To illustrate this, let’s assume you had $10,000 in Canadian funds available to buy a U.S.-listed ETF. As I write this on late Monday morning, February 8, 2021, the rate to exchange $10,000 in Canadian funds is 1.2904, which transferred over to the USD side of the account results in $7,749.54. I then want to buy shares of VTI, which as of this moment has an ask price of $204.96 in USD. Subtracting from my cash balance the $9.99 commission that I would pay to make this purchase, I am able to buy 37 shares. Fractional shares are not permitted, unlike with mutual funds.


The following table illustrates the process:



If you purchase the U.S.-listed ETF in the CAD side of your account, you will experience essentially the same foreign exchange rate, but you won’t have any USD cash remaining. Now, what if you are an active trader trying to make small gains on a regular basis. You buy the ETF as above, but it’s all done in the CAD side of your account. Let’s assume the same exchange rate and the same Adjusted Cost Base (typically this is the cost to purchase the security plus the commission). You want to make a $100 profit in CAD, which based on the exchange rate at the time you bought it, is $77.50 in USD. Adding in the $9.99 commission to sell it, you know you need to get US$7,681 or US$207.60 per share. You enter a limit order to sell at $207.60 and wait. The order triggers and you look at the transaction to see what you got in CAD.


The table below shows the transaction.



You are astounded. How could you make money in USD but lose money in CAD? The answer, of course, lies in the foreign exchange rate. In this scenario, the value of the CAD against the USD had not changed. The only difference is that when you were buying the USD ETF, you were effectively selling your CAD and buying USD. When you were selling your USD ETF, you were selling USD and buying CAD. As you may know, your financial institution will charge a “spread” between the buy rate and the sell rate when you enter into a foreign exchange transaction.


What’s the lesson here? Don’t frequently flip back and forth between USD and CAD when you invest. You will lose on the exchange rate every time. For the most part, I would probably avoid USD investment accounts unless I planned to invest in USD securities over the long term.


An Alternative: Norbert’s Gambit

There is an alternative to being hit by the exchange rate spreads. Norbert’s Gambit, named after Norbert Schlenker, who ran an investment management firm from Salt Spring Island in BC, involves using a security that trades in both CAD and USD. The major banks are all among those that trade on both the Toronto Stock Exchange in CAD and on the New York Stock Exchange in USD. I will use Royal Bank of Canada (RY) as it is the largest of Canada’s banks. As I write this, it’s bid/ask in CAD is $107.23/$107.24. In USD it is $84.09/$84.11. If you have $10,000 CAD that you want to switch into USD, this is how it will work out:



A few things to note.


  • In my experience, the only way that you could make this arrangement during the same day was in a non-registered account, since you are effectively “short” on the USD side until the shares bought on the CAD side are transferred over at settlement (two business days after the trade date). You are not allowed to be short in a registered account.
  • Generally speaking you will have to contact an investment representative to sell the shares short on the USD side of the account.
  • If you wish to accomplish Norbert’s Gambit in a registered account or avoid paying the higher representative-assisted commission, then there will be a delay involved. You will have to buy your CAD shares on one day, wait two business days until your buy order settles, and then journal (transfer) them over the USD side. In that time, you open yourself up to two risks. One is that the security you are using (RY in this case) will go down in value and that the CAD will weaken against the USD. An increase in one could offset the decrease in the other, or you might find that the stock goes up and the CAD goes up, in which case you get a double win, but there is a risk involved, nonetheless.
  • The larger the dollar value that is involved, the better, in that the cost of the commissions takes up a relatively smaller overall cost.
  • While you can use any number of inter-listed stocks to accomplish Norbert’s Gambit, another option that is quite popular is to use the Horizons U.S. Dollar Currency ETF. DLR is the CAD symbol and DLR.U is the USD symbol. If you wish to convert CAD to USD, you buy DLR on the CAD side, and sell DLR.U on the USD side. Transferring DLR from the CAD side after settlement covers the resulting short from the sale of DLR.U. DLR/DLR.U can be considered superior to using shares of a company as you are only exposed to fluctuation in the foreign exchange rate.


Tax Issues

Adjusted Cost Base Tracking

If you hold a U.S. security in a non-registered account, you need to keep track of the Adjusted Cost Base (ACB). As mentioned above, that is typically the price you paid plus any associated commissions. You will need to know the exchange rate in effect at the time of your purchase because the Canada Revenue Agency wants a figure in Canadian dollars. If you buy that USD security over multiple times, you need to obtain the exchange rate in effect at the time of each purchase. I suggest you bookmark the Daily Exchange Rates page of the Bank of Canada website.


U.S. Estate Tax Filing Issues

If you own over US$60,000 in U.S. situs assets at the time of your death, your estate will have to file a U.S. tax return, even if no tax is payable. Included in the term U.S. situs assets are stocks and ETFs that are listed on U.S. markets. To be clear, this requirement to file a U.S. estate tax return does not apply to securities of Canadian companies that are inter-listed in both Canadian and U.S. markets.


U.S. Currency without U.S. Estate Tax Filing Issues

How should you avoid this estate tax filing issue?


  • If you have already exceeded the US$60,000 threshold, consider selling down your holdings to well below US$60,000.
  • If your investment plan guides you to maintain holdings in USD greater than $60,000, consider buying Canadian ETFs that are denominated in USD. The table below shows some examples, including a couple of mutual funds.



You will note that the two ETFs on the left are simply the USD equivalents of the Canadian-listed ETFs noted earlier.


Accounts Types and U.S.-Listed Securities

Dividends paid from U.S.-listed ETFs (or U.S. stocks for that matter) are subject to a 15% withholding tax.


Non-Registered Accounts

In a non-registered USD account, you will typically get a T5 from your investment firm which documents the foreign tax paid, which you can claim on your tax return.


Registered Retirement Savings Plans

The RRSP and the RRIF are both recognized retirement accounts per a treaty between the United States and Canada. As a result, if you own a U.S.-listed ETF or stock which pays a dividend in your RRSP/RRIF, the IRS will not apply the 15% withholding tax.


Tax-Free Savings Account

From the point of view of avoiding tax on dividends from U.S.-listed ETFs, the TFSA is the worst choice. First, the TFSA is not a recognized account type under U.S. tax law, so the 15% withholding tax will apply. Second, as it is a TFSA, you will not receive a T5 to claim the withholding tax.


Canadian-Listed USD ETFs

For estate planning reasons, you may choose to reduce or eliminate your holdings in U.S.-listed ETFs and use Canadian-listed USD ETFs instead. You should note that the 15% withholding tax on U.S.-source dividends is applied at the fund level and is unrecoverable in both TFSAs and RRSPs/RRIFs. If held in a non-registered account, however, your T-slip should document the foreign tax paid, as described above.


The Value of Capital Gains

Having said that, 15% of what is perhaps a relatively small dividend, may not mean much in any of the account types if your primary goal for holding U.S. securities is capital gains, which attracts no taxation from the IRS.


A Practical Benefit of a USD Non-Registered Account

A final item I will note is that the benefit of holding either U.S.-listed securities or Canadian-listed USD securities in a USD account is often made plain when you travel to the United States. A simple way to handle money while you travel in the U.S. is to take with you a relatively small amount of US cash and pay most of your expenses with a USD credit card. Combined with a USD bank account at your financial institution (banks and many credit unions offer this service), you can cover part or all of your travelling expenses south of the border by withdrawing dividends and interest from your USD non-registered account. Concerns about spreads on exchange rates cease being an issue. Of course, the ability to travel will remain a challenge for the next several months, but I am sure we are all hoping that will be resolved this year.


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Disclaimer: This blog post is intended for general information and discussion purposes only. It should not be relied upon for investment, insurance, tax, or legal decisions.

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