|Contributed by: martingale |
Barclays has announced changes to several of its Canadian iShares exchange traded funds (formerly iUnits), including the XSP/i500R iUnits, and XIN/iIntR iUnits funds. The fees and the investment objectives of each exchange traded fund is changing. Since I had previously recommended these Canadian iShares funds to self-directed RRSP investors it is time to analyze the implication of these changes. This is the first of a series of articles--subsequent articles will look at the changes to other Canadian iShares funds.
The recent elimination of the RRSP foreign content rule required a revamping of Barclays Canadian iShares funds with foreign content: The XSP Canadian iShares which tracks the American S&P 500 and the XIN Canadian iShares which tracked the overseas EAFE were suddenly irrelevant. Since RRSP investors can now invest directly in foreign securities, why buy the more expensive Canadian versions? There are very good, very cheap US market indexes from Vanguard and others that you can now purchase directly; similarly, there are good cheap overseas ETF's available on the U.S. market that are an attractive alternative to XIN.
Barclays' new idea for these Canadian iShares exchange traded funds is to concentrate on eliminating "currency risk". The idea is to give you a way of investing in American and overseas securities without having to worry about fluctuations in the Canadian dollar. Given the massive appreciation of the Canadian dollar over the past few years this certainly seems like a good idea--but it is not necessarily. It requires careful thought.
Is "currency risk" something you should avoid? Or is it like market risk--something you should seek out? This is a very complex question and the answer depends on your own individual financial situation. Before we go too far with that, let's first understand what the risks are here.
What is the risk of having no "currency risk"? The answer is Canadian dollar inflation. Suppose you invested in the US market directly, and then over the next ten years Canadian currency suffered a higher rate of inflation than US currency did. You would be protected from some of this inflation by your foreign investments--the troubles in the Canadian economy would not affect your US holdings. Similarly, if you held Canadian equities during a period of inflation they could inflate along with everything else leaving you with an acceptable amount of buying power.
Now it is clear what the problem with the new XSP/XIN Canadian iShares could be: By investing in these "foreign" securities you will not be protected from problems in the Canadian economy! If the Canadian dollar suffers undue inflation because of a financial or political crisis in Canada (Quebec separates?) you will lose a lot of buying power. One of the main reasons to invest in foreign securities in the first place is precisely because you want to protect yourself from events that only affect Canadian corporations!
Thus, a very strong argument can be made that if foreign securities made sense for you before, that they still make sense to you today, and that you should prefer to hold them in a foreign currency. The new XSP and XIN Canadian iShares are thus bad news for you, and you should avoid them--instead you should look at the alternatives you can now freely buy on the U.S. market.
However (there is always a however) that is not the case for everyone. If you already know that you cannot afford exposure to foreign currency (you know what your expenses will be, and they are all in Canadian dollars) then this could be very good news for you. In this case, you probably avoided foreign securities up until now, out of fear of currency fluctuations. If that is your situation then you certainly could increase your diversification by holding XSP and XIN but without suffering any currency risk.
In general, a better way to manage your currency risk, in my opinion, is to hold your fixed income holdings entirely in Canadian dollars and invest only a smaller amount of money in foreign equities. You can get your foreign currency exposure down to quite a small number this way, and the amount of "currency risk" you face declines as you approach retirement (because your fixed income holdings should then dominate your investments.)
In summary, if it was good for you to be invested in foreign securities before it still is--and you should invest in truly foreign equities, not Canadian-foreign hybrids. However, if you had previously avoided foreign investments out of fear of currency risk then the new versions of the XSP and XIN Canadian iShares could be quite good for you.