Canadians: Moving US assets to currency hedged ETF

[RichMoose]

I've been contemplating this move for a few weeks now, since the end of January really. Finally today I pulled the trigger and moved about 60% of my RRSP portfolio from the normal US Index ETF (VFV.TO) to the currency-hedged version (VSP.TO). This of course means the remaining 40% is still in VFV.TO. Both VFV.TO and VSP.TO have the same low 0.08% MER. I also trust Vanguard's expertise in keeping currency hedging costs low.

The biggest reason for my move is that the returns of VFV.TO have been juiced significantly by the depreciation of the Canadian dollar. In the last 6 months, the value of my VFV.TO has increased over 20%. During that same time, the S&P500 has increased just 5.5%. Because I will not book any capital gains due to trading inside my RRSP account, the move costed me just $12 in trading fees. Not bad!

I realize the CAD might fall even more for some time, but on the other hand I believe it's below what it "should be" over the long term. For this reason I kept the 40% in VFV.TO for now. If the CAD falls below 70 cents I can see myself selling the remainder. On the other hand, if it goes back up to 90 cents from here, at least I won't get currency wacked on the full value of my US holdings.

This amounts to a bit of market timing I guess, if you want to get picky. Hopefully my breaking the rules doesn't end badly.

Any other Canadians considering this, or maybe have done it already?

[FI40]

moved about 60% of my RRSP portfolio from the normal US Index ETF (VFV.TO) to the currency-hedged version (VSP.TO).

Yeah, I can see why you would do this. VFV has been phenomenal in the last few years and part of me wants to take a gain and run. This seems like a way to at least take some of the FX gain.

I realize the CAD might fall even more for some time, but on the other hand I believe it's below what it "should be" over the long term.

I'm not so sure about this part. Why do you think it should be any particular ratio? I'm curious to know your reasoning. I'm not really sure how fx rates should be estimated other than just looking at historical data, which is probably not very smart.

Also, I hold VFV in a taxable account, so any selling would trigger significant capital gains. That's another big reason I won't be doing this.

[Al1961]

Sounds like market timing to me.

[RichMoose]

I'm not so sure about this part. Why do you think it should be any particular ratio? I'm curious to know your reasoning. I'm not really sure how fx rates should be estimated other than just looking at historical data, which is probably not very smart.

Currency exchange rates over the short term are wacky and all over the place. There's a lot of speculation and emotion in the market place. The longer term valuation of currency is easier to calculate because it depends on a few major things:

1) Political and monetary stability - the US and Canada are both politically stable and have similar monetary policies (ie. target inflation rate banking with both countries aiming for 1 - 3% inflation). In fact, one could easily make a case that we are more stable than the US in many ways.

2) Purchasing power parity - simply the amount of any given basket of products that each currency can purchase. It takes more money to buy things in Canada vs the US for a few basic factors: we have a lower population density, we have a smaller market for goods, we are less innovative, we have less trading connections, we are less productive (to the tune of ~80% of US productivity per capita), and we have a somewhat tighter controlled marketplace (more protected industries particularly in agriculture).

3) Interest rates - ties in with monetary stability in many ways. Canada and the US have similar interest rates so our assets are similarly attractive to foreign buyers. If interest rates in Canada were much higher than the US, the CAD would appreciate vs. USD because foreign investors would be buying Canadian debt instead of US debt eventually to the point where there would be no net benefit to buying Canadian debt due to CAD being more expensive. Currently our government pays lower long term bond yields than the US.

4) Economic condition/value - this refers to the general condition of the overall economy as well as our economic value in natural resources and human resources. If our economy is more attractive than the US economy investors will buy CAD to invest in Canadian companies, pushing up the value of the CAD.

I believe the CAD, over the long-term, should be valued somewhere around 90 cents. We are less productive, but have more natural resource value per capita, are more stable politically, and have a stable central bank. This is, of course, purely my own personal belief and I'm not a currency trader because I believe that currency valuations are erratic and change for no rhyme or reason.

[FI40]

I suspect you would find the following things to be relevant:

• Food items generally cost around 50% more in Canada in Canadian dollars than they do in the US in US dollars. (In other words, if an item is US$1 then it might be CA$1.50.) We'll say food items are "50% nominally more expensive".
• Electronics are often 2-10% nominally more expensive, just high enough to make it generally unprofitable to import them from the US.
• Real estate is far more nominally expensive on average in Canada. Property taxes are generally higher too.
• Canada is very cold. (As a Canadian, I can say this without any nuance.)
• Canada has a single-payer health care system.
• Inflation in Canada is about one percentage point higher than in the US.

The longer term valuation of currency is easier to calculate because it depends on a few major things:

1) Political and monetary stability - the US and Canada are both politically stable and have similar monetary policies (ie. target inflation rate banking with both countries aiming for 1 - 3% inflation). In fact, one could easily make a case that we are more stable than the US in many ways.

2) Purchasing power parity - simply the amount of any given basket of products that each currency can purchase. It takes more money to buy things in Canada vs the US for a few basic factors: we have a lower population density, we have a smaller market for goods, we are less innovative, we have less trading connections, we are less productive (to the tune of ~80% of US productivity per capita), and we have a somewhat tighter controlled marketplace (more protected industries particularly in agriculture).

3) Interest rates - ties in with monetary stability in many ways. Canada and the US have similar interest rates so our assets are similarly attractive to foreign buyers. If interest rates in Canada were much higher than the US, the CAD would appreciate vs. USD because foreign investors would be buying Canadian debt instead of US debt eventually to the point where there would be no net benefit to buying Canadian debt due to CAD being more expensive. Currently our government pays lower long term bond yields than the US.

4) Economic condition/value - this refers to the general condition of the overall economy as well as our economic value in natural resources and human resources. If our economy is more attractive than the US economy investors will buy CAD to invest in Canadian companies, pushing up the value of the CAD.

Good points. I think you guys are right about these driving factors and that's a decent list of them. Not sure I agree with the conclusions/predictions though because there are many offsetting factors.

If you were so inclined, you could do some factor analysis on inflation, rates, CPI measures, etc. in gauging their effect on FX rates historically. You could build a complicated model, calibrate it, and use it to predict where FX rates will go in the future. You guys may already be doing that or more likely just have an intuitive feel for it.
But economists and FX traders are doing that too (some are very sophisticated), and it's a pretty efficient market, so again I'm not swayed into even trying to form an opinion about where FX rates are going. I think the strategy of diversifying and keeping costs low (i.e. not currency hedging stock ETFs) is the best a priori strategy and is therefore the best strategy in this case because to me this is still unknowable.

[MMMdude]

I have thought about this too - just that I own ZSP instead of the Vanguard alternative and I've made a killing off it, wish I was more into US equities than I have been.  I am thinking of partially flipping into XSP (and new additions too).  Just compare ZSP vs XSP on Google Finance - it's a huge spread in performance.  I agree the CDN "should" go higher relative to USD but man the US Dollar is just steamrolling other currencies with no signs of slowing.

XSP is hedged and ZSP is unhedged - both iShares products