- Arguments in favor of publicly traded ETFs in Canada
Currency Considerations
For Canadian investors, currency risk is an important factor to consider when investing in foreign assets. A Canadian-listed ETF, which is denominated in Canadian dollars, mitigates the currency risk associated with fluctuations between the Canadian dollar and the US dollar. When an advisor recommends a U.S.-listed ETF to a Canadian client, they consider the possibility that exchange rate fluctuations could undermine investment returns.
For clients who prefer to avoid this risk or for whom the increased complexity of currency hedging is undesirable, Canadian-listed ETFs represent a simple solution. Many Canadian-listed ETFs offer currency-hedged versions, which aim to neutralize the effects of currency fluctuations on fund returns. This can be beneficial for investors who primarily target the return of the underlying assets rather than the additional level of currency fluctuation.
Investors also have access to many Canadian-listed ETFs offered in U.S. dollars, which provides greater flexibility in managing currency exposure.
Tax efficiency and other tax considerations
Tax efficiency is another crucial factor to consider when purchasing ETF shares. For Canadian investors, investing in Canadian-listed ETFs may be more tax efficient in non-registered accounts. Canadian ETFs are subject to Canadian tax laws, and distributions from such ETFs are treated as Canadian source income, which may be subject to more favorable taxation than foreign income.
Additionally, when it comes to retirement savings plans like Registered Retirement Savings Plans (RRSPs), publicly traded ETFs in Canada provide a significant tax advantage in general.
It is important for advisors to consider that when a Canadian investor holds U.S. securities directly or through a U.S.-listed ETF, they are subject to a 15% foreign withholding tax. on dividends from American sources. However, under a tax treaty between Canada and the United States, this withholding tax on income from American sources can be avoided if an RRSP directly holds the American securities. On the other hand, holding an ETF listed on a stock exchange in Canada that invests in American securities, in an RRSP, does not allow you to benefit from the same exemption from withholding tax. If a Canadian investor is looking to maximize the tax efficiency of their RRSP, a US-listed ETF may be an investment to consider for exposure to their foreign assets.
If a client is investing in a registered account or TFSA, when adding exposure to foreign stocks, purchasing units of a Canadian-listed ETF that directly acquires foreign stocks may allow you to avoid double withholding of foreign taxes. If investing in a tax-free account, when you add exposure to U.S. Treasury bonds, purchasing units of a Canadian-listed ETF may allow you to avoid foreign withholding tax.
It is always prudent for a Canadian investor to have a better understanding of other tax factors before investing in a US ETF. For example, U.S. ETFs are considered U.S. assets for U.S. estate tax purposes, regardless of the investor’s residency or citizenship. Unlike the Canadian tax system, the American tax system taxes the value of assets held by the deceased person. A Canadian resident holding a U.S. ETF may be subject to U.S. estate tax and Canadian income tax upon death. Additionally, a Canadian investor will need to file Form T1135 and file it with the Canada Revenue Agency if the total cost of the foreign property they own exceeds $100,000 at any time during the year.
Regulatory environment and familiarity
ETFs listed in Canada are regulated by Canadian securities regulators, which can provide a sense of security and familiarity to Canadian investors and their advisors. The Canadian regulatory environment, with its disclosure and compliance requirements, ensures that investors are well protected. This familiarity can help advisors explain the structure, risks and potential benefits of the product to their clients, promoting confidence in investing. Additionally, Canadian-listed ETFs often have lower management expense ratios (MERs) than their U.S. counterparts when taking into account the exchange rate and related costs. For cost-conscious investors, this can be a compelling reason to choose Canadian ETFs.
Accessibility and simplicity
Canadian-listed ETFs are easily accessible through Canadian brokerage accounts, simplifying the process for advisors and clients. There is no need to deal with cross-border trading or the complexities associated with holding foreign securities, such as additional U.S. tax reporting requirements. This ease of access and simplicity may be particularly attractive to clients who prefer a simpler investment process.
ETFs listed on an exchange in Canada may be better suited to investors looking to avoid unexpected costs associated with currency conversion, which can arise when purchasing shares of ETFs listed on an exchange in the United States through a Canadian brokerage account. These conversion fees can add up, especially for investors who trade frequently, reducing overall returns.
- Arguments in favor of publicly traded ETFs in the United States
Exposure to US markets and diversification
In some scenarios, a US-listed ETF may be the most appropriate choice, particularly for clients with a strong US market bias. U.S.-listed ETFs provide direct exposure to the world’s largest and most liquid market, providing access to a broader range of companies and sectors, including those not easily accessible by through publicly traded ETFs in Canada. For clients with significant U.S. dollar-denominated assets or those who anticipate future spending in U.S. dollars, U.S. publicly traded ETFs can serve as a natural hedge against currency risk. In this type of scenario, holding U.S.-listed ETFs aligns the currency of the investment with that of future liabilities, thereby reducing currency risk. ETFs listed on exchanges in the United States tend to have higher trading volumes and tighter bid-ask spreads compared to ETFs listed on exchanges in Canada, which may result in lower costs transaction for investors. For clients who prioritize liquidity and profitability, especially in large or frequent trades, U.S.-listed ETFs may be a better option.
Specific investment strategies and product availability
Certain investment strategies or exposures may only be offered through U.S. publicly traded ETFs. The U.S. ETF market is much larger and more diverse than Canada’s, offering a wide range of niche products and strategies. For example, advisors looking to implement a particular thematic investment strategy, such as exposure to emerging technologies or specific sectors like biotechnology, may find that the appropriate ETF is only available in the U.S. market. Additionally, U.S.-listed ETFs often have longer track records and larger assets under management, which can be reassuring for investors seeking stability and an established performance history.
US customers and cross-border considerations
For advisors with U.S. clients or clients with significant ties to the United States, such as individuals who are dual citizens or individuals who have property or business interests in the United States, publicly traded ETFs in the United States United States is often the preferred choice. For U.S. or Canadian clients who spend a significant amount of time in the United States or plan to retire there, it may be beneficial to hold ETFs listed on U.S. exchanges.
These clients may have current spending in U.S. dollars and could benefit from investments denominated in the currency that matches that of their spending. At the same time, holding publicly traded ETFs in Canada can be a powerful estate planning tool for U.S. residents who invest in Canadian ETFs denominated in U.S. dollars, allowing them to still align with the currency of their expenses.
The choice between Canadian publicly traded ETFs and U.S. publicly traded ETFs is complex, requiring advisors to carefully consider their clients’ circumstances, including tax implications, currency exposure , investment objectives and the regulatory environment. Canadian-listed ETFs offer benefits like currency stability, tax efficiency in non-registered accounts, and awareness of Canadian regulations, making them a great choice for many Canadian investors. In some special circumstances, such as seeking direct exposure to the U.S. market, implementing niche investment strategies, or addressing cross-border tax and currency concerns, state-listed ETFs -United might be the most suitable option.
The choice between these two types of ETFs should be guided by a thorough understanding of the client’s needs and a strategic approach to optimizing their investment portfolio within their broader financial goals. Advisors who can skillfully navigate these considerations will be well-positioned to add value for their clients and help them achieve their financial goals.
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Please note that this material is provided for informational purposes only to assist readers when consulting their legal, tax and compliance advisors regarding their obligations and duties.
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