Beyond paying brokerage commissions/spreads for currency conversions, you’re also getting fewer U.S. dollars for every Canadian dollar you exchange. Fortunately, exchange-traded funds (ETFs) offer several ways to hedge against this weakening Canadian dollar. Here’s a look at some options to consider.
Unhedged U.S. equity ETFs
The first option, which you’re likely already exposed to in your portfolio, is unhedged U.S. equity ETFs. Here’s how it works:
Vanguard S&P 500 Index ETF (VFV) is a popular one. It holds the USD-denominated Vanguard S&P 500 ETF (VOO) but does not use derivatives to cancel out currency fluctuations between U.S. and Canadian currencies. As a result, when the U.S. dollar strengthens, the price of VFV rises beyond just the movements of the S&P 500 index.
Why? Because VFV is denominated in Canadian dollars, while its underlying assets are in American dollars. When the USD appreciates, those USD-denominated holdings are worth more in Canadian dollars. This currency effect is why VFV has outperformed its currency-hedged counterpart, the Vanguard S&P 500 Index ETF (CAD-hedged) (VSP), over the last decade.
Over a 10-year trailing time frame, as of December 31, the U.S. dollar generally appreciated versus the Canadian dollar, boosting VFV’s total NAV return to 15.15% compared to VSP’s 11.59%. So, if you already own VFV or another unhedged U.S. equity ETF, you’re inherently protected against a weaker CAD and even stand to benefit from a stronger USD.
However, keep in mind that the reverse is also true. If the CAD strengthens and the USD depreciates, VFV could lose additional value beyond the movements of the S&P 500 index. (Read: “Is VFV a good buy?”)
Global X US Dollar Currency ETF (DLR)
If you’ve ever used Norbert’s Gambit at your brokerage to cheaply convert Canadian money into American, you’re likely already familiar with the Global X US Dollar Currency ETF (DLR). If not, know that the process is pretty simple: you buy DLR with Canadian money, request your brokerage to “journal it over” to the USD-denominated DLR.U, and then sell DLR.U for U.S. dollars.
That said, DLR isn’t limited to currency conversion. It can also serve as a cash management tool. By holding DLR, you’re effectively going long on the U.S. dollar, while earning the risk-free rate. Currently, it pays a 4.44% annualized distribution yield.
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