Are 2 New Canadian iShares ETF Worthwhile?

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 it 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 (EFA), iShares CDN S&P 500 Index and iShares CDN Russell 2000 Index Funds (IWM). These three existing iShares foreign-equity ETFs are currency hedged (back to Canadian dollars).

Why not invest in the underlying U.S.-based ETFs instead?

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 main reason for investing in the iShares ETFs instead of their U.S.-based counterparts is, as given in the iShares news release, 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.”

Comments

[ETF Grind:]

Why not invest in Vanguard's US index instead?

The VWO has a much better expense ratio than the EEM.

Also, some Canadian investors may face high fees on the NYSE Arca.

Jun 25 04:29 PM

[Dingle Dangle:]

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).

Jun 26 10:29 AM