By: Larry MacDonald
Two new iShares exchange-traded funds (ETFs) began trading yesterday on the Toronto Stock Exchange. They give Canadians new ways to diversify into foreign stock markets. Coverage that I have seen so far includes pieces by Jonathan Chevreau and Rudy Luukko.
iShares CDN MSCI World Index Fund (XWD)
- tracks the MSCI World Index, which covers 1,500 stocks from 23 developed markets, including Canada and the United States (but not emerging markets)
- it does this by investing in U.S-based, country-focused iShares ETFs in proportion to the weighting pattern in the MSCI World Index
- MER is 0.45%
- denominated in U.S. dollars (not hedged back to Canadian dollars)
- because invests in a large number of countries, foreign currency exposure will be broadly diversified
iShares CDN MSCI Emerging Markets Index Fund (XEM)
- tracks MSCI Emerging Markets Index, which cover stocks in emerging countries
- does this by investing in U.S.-based iShares MSCI Emerging Markets ETF (EEM)
- MER is 0.82%
- denominated in U.S. dollars (not hedged back to Canadian dollars)
- because invests in a large number of countries, foreign currency exposure will be broadly diversified
These new ETFs join the three other foreign-equity iShares ETFs: iShares CDN MSCI EAFE Index, iShares CDN S&P 500 Index and iShares CDN Russell 2000 Index Funds. These three existing iShares foreign-equity ETFs are currency hedged (back to Canadian dollars).
Why not invest in U.S.-based ETFs instead?
Are the two new ETFs worth investing in? Why not just invest in U.S.-based ETFs tracking the same markets with lower MERs — like those in the Vanguard group?
The main reason for investing in the iShares ETFs instead of U.S.-based ETFs, as given in the iShares news release, is to avoid “… estate tax considerations usually associated with U.S.-listed ETFs.” This is a reference to the fact that Canadians owning U.S. assets face a U.S. estate tax on those assets in the event of their death.
However, if the value of a Canadian’s worldwide gross estate is less than $3.5 million (U.S), they are exempt in 2009. In 2010, there will be no limit.
The threshold will come down to $1.78 million (U.S.) in 2011, which includes $780,000 in credits. Another $780,000 U.S. in credits is available if your assets are willed to your spouse. This would bring the effective ceiling to $2.5 million (U.S), which still leaves most Canadians unaffected. It would appear most Canadians thus need not worry about U.S. estate taxes.
Even if one is over the threshold, there are several strategies for minimizing U.S. estate taxes. For example, one can hold U.S. assets in a corporation (as discussed in tax guides such as Tim Cestnick’s 101 Tax Secrets for Canadians (2008 edition).
Investing directly in the U.S.-based ETFs also avoids extra tax, according to posts by Canadian Capitalist blogger. As he concludes:
“If a Canadian ETF simply holds a U.S.-listed ETF, an additional tax drag is created due to withholding taxes that are not recoverable when the ETF is held within a RRSP account. It may be cheaper, instead, to simply hold the US-listed ETF directly.”
10 Responses to “ Two new iShares ETFs worthwhile? ”
Thanks for the mention Larry. I blogged about this today and reached the same conclusions as you. I personally own VTI, VEA and VWO but see no reason to switch to these ETFs. They are more expensive and have extra drag from withholding taxes.
It would be very nice if an ETF vendor introduces a one-stop foreign stock ETF (equivalent to holding VTI+VEA+VWO) for a reasonable MER.
By Canadian Capitalist on Jun 25, 2009
Of course by trading on the TSX an investor will not have to convert their CAD to USD before buying (a cost generally ~1%) and the same on the way back again.
This is a serious saving for most retail investors and will offset the higher fees unless an investor is planning on holding for the long term.
An investor would have to hold the product for more than 20 years for the 0.1% additional annual fee to be larger than the alternate 2% FX fees (1% in and 1% out).
By ETF Guru on Jun 26, 2009
ETF Guru
The difference in MERs is quite a bit more than 0.1% if one uses a low-cost family of U.S.-based ETFs that track the same populations. Of note:
i) Vanguard Emerging Markets Stock ETF has a MER of 0.2% vs. a MER of 0.85% for CDN MSCI Emerging Markets Index Fund.
ii) Vanguard Europe Pacific ETF (VEA)has a MER of 0.11% vs. a MER of 0.65% for iShares CDN MSCI World Index Fund.
By Larry MacDonald on Jun 26, 2009
Thanks Larry.
My response was to your point
‘Are two new ETFs worth investing in? Why not just invest in the underlying U.S.-based ETFs that they invest in? After all, they are in U.S. dollars too yet their MERs are lower.’
The fee for XEM is 82bps (not 85) and the underlying is EEM US which charges 72bps. Thus an investor is paying 10 bps premium per annum to hold a Canadian stock and avoid FX commissions.
The fee for XWD is 45 bps (note not the 65 bps you quote) and the various underlying US iShares charge between 9 and 52 bps (a index weighted average comes out at around 25 bps). Thus a Canadian investor is paying a 20 bps premium per annum and again avoiding 2% round trip FX commissions. Only a Canadian investor investing for more than 10 years would benefit from holding the USD iShares.
Of course, if you don’t compare the Canadian iShares to the underlying US iShares but compare them to other, cheaper products the analysis changes somewhat. VWO follows the MSCI Select Emerging Mkts Index, a less established and less widely followed index than EEM’s MSCI Emerging Market’s Index, and thus it’s probably a cheaper index for Vanguard to buy the rights to. This does trade at a lower 25 bps, so would be a cheaper investment for a Canadian investor than XEM if held for longer than around 3.5 years (assuming the investor is happy with the less well known index).
Your second suggestion makes less sense. VEA invests in developed world markets outside North America, while XWD includes North America. The two products are very different as a result and should not be compared directly.
The bottom line is that investors must do their homework on the underlying exposure they want and then find a good quality product that achieves this exposure. If investors concentrate on minimising fees and don’t pay attention to the composition of the products they are investing in they may not achieve the goals they are seeking.
By ETF Guru on Jun 26, 2009
ETFGuru: VWO does track the MSCI Emerging Markets Index since the Fall of 2006. So, it is fair to compare XEM to VWO and XWD to a blend of VTI and VEA because we are talking about equivalent ETFs.
Holding XEM and XWD (or any Canadian ETF that holds US-listed ETF), instead of the US ETFs directly within a RRSP has an additional problem: the US withholding taxes are not recoverable. This would add a further drag of 45 basis points, assuming a 3% dividend yield.
I don’t know why anyone planning to hold for less than 10 years would be in stocks in the first place. Stocks are long-term investments. The longer the holding periods, the better — at least 20 years is ideal.
By Canadian Capitalist on Jun 27, 2009
ETF Guru
I have revised the passage in the blog post to make the basic idea clearer – i.e. investors can index to the same markets as the two new ETFs at noticeably lower MERs by using U.S-based ETFs. As for the MER numbers, I would go by the figures cited in my original blog post (rather than those in a hurriedly written note to the comments section). As for the Vanguard ETFs, they were just intended to be illustrative of the main point that MERs are notably lower for the U.S-based ETFs. But I wouldn’t go so far as to say the Vanguard Europe Pacific ETF (VEA) does not make any sense to use. It can be made comparable to the iShares CDN MSCI World Index Fund by adding the Vanguard ETF for the U.S. market and an ETF for Canada. Indeed, the combined MER of this group would be even lower, I believe. See Canadian Capitalists’ comment for some other points that could have been made.
By Larry MacDonald on Jun 27, 2009
Canadian Capitalist
Thanks for pointing those things out. I hadn’t thought of your third point about investing for the long run (had overlooked it). It is of course a good one to make in this context.
By Larry MacDonald on Jun 27, 2009