Written by Amy Legate-Wolfe at The Motley Fool Canada
A Canadian investor can own the S&P 500, watch the account rise and congratulate America’s biggest companies. Sometimes the currency deserves a thank-you card too.
The U.S. dollar has strengthened again, and that can boost Canadian-dollar returns from U.S. stocks even when the underlying companies haven’t moved nearly as much.
That makes the Vanguard S&P 500 Index ETF (TSX: VFV) a useful example of why the currency listed beside your exchange-traded fund (ETF) isn’t necessarily the currency risk hiding inside it.
Canadian ticker, American exposure
VFV trades in Canadian dollars on the TSX. Underneath, it provides exposure to the S&P 500 and leaves that U.S.-dollar currency exposure unhedged.
So investors receive two moving pieces. First, the return of U.S. stocks, then the change in the U.S. dollar versus the Canadian dollar. Those effects can multiply dramatically.
If U.S. equities gain 8% while the U.S. dollar appreciates 5% versus the Canadian dollar, the combined gain is roughly 13.4%, before expenses and tracking differences. That’s why understanding how ETFs work matters more than simply reading the ticker.
Invest $10,000
Here’s what could happen if you hold the U.S. stock return at 8% and change only the currency.
Currency can also soften a decline. If U.S. stocks fell 10% while the U.S. dollar rose 5% against the Canadian dollar, the combined result would be roughly negative 5.5%. Sure, that’s helpful. But it’s certainly not a reliable hedging strategy. Exchange rates can just as easily amplify losses.
Cheap doesn’t mean diversified everywhere
VFV’s management expense ratio is only 0.08%. That works out to about $8 annually on a constant $10,000 balance, although actual fees vary with the value of the investment and are deducted within the fund.
The bigger issue is concentration. As of August 31, approximately 37.8% of the fund sat in its 10 largest listed positions. So while VFV owns roughly 500 large U.S. companies, a surprisingly large chunk of the portfolio depends on a handful of giants.
Geography matters too. VFV is U.S. equity exposure, not a complete global portfolio. An investor already holding a global ETF, technology stocks or another S&P 500 fund may own the same businesses several times.
Bottom line
There are risks to consider. At roughly $196.60, $10,000 buys 50 whole VFV units for $9,830. I’d use those units as a deliberate U.S. allocation rather than a complete portfolio.
