Q&A – iShares or Vanguard, Hedged or Unhedged

Which Low-Cost Index ETF Should I Choose?

I enjoyed your presentation. One thing in particular that really stood out to me were your thoughts on fund management and fees. I would like to take action on my own account, setting up a self directed RRSP containing one of the ETFs you spoke about. I’m writing to confirm the instrument you were referring to (see below).

Do you see a difference between Blackrock’s iShares ETFs and Vanguards’ ETFs? Vanguard fees are slightly lower.

Blackrock iShares

  1. XUS – iShares Core S&P 500 Index ETF:  0.1% MER, 5Y annual rate of return=13.63%;
  2. XSP – iShares Core S&P 500 Index ETF (CAD- Hedged): 0.11% MER, 5Y annual rate of return=7.57%.

Vanguard

  1. VFV – S&P 500 Index ETF: .08% MER, 5Y annual rate of return=13.64%;
  2. VSP – S&P 500 Index ETF (CAD-hedged): 0.08% MER, 5Y annual rate of return=7.58%.

The hedged products seems to produce 50% less return. It doesn’t seem worth the price.

Answer

I’m glad you enjoyed the presentation and were able to gain insight into the damaging effects of mutual funds and their fees over our investing lifetime. As discussed, it’s a “sales & marketing industry” and not an investment industry.

To answer your question, I believe there is little difference between the holdings of the these products. Thus, if VFV has an MER of 0.08% and XUS has an MER of 0.10%, I’d naturally choose VFV.

Because of the slightly lower fees, I generally recommend that young people who are saving for the long (30+ years) term investm monthly in VFV. I steered them away from the currency hedged products (e.g., VSP) – but not for the reason you suggested. Rather, because of their long-term horizon and regular contributions, I did not feel the additional (albeit minimal) cost of currency hedging was justified since they’d be buying regularly through both up’s and down’s of the CAD vs. USD rate.

It is not surprising that the currency-hedged products have performed much poorer than the unhedged products over the past 5 years. However, this has little (nothing?) to do with the underlying investments and (almost) everything to do with the fluctuations in the CAD/USD exchange rates over this time period. If you’ll recall, around 2012, CAD was on-par with (actually a bit higher than) USD. Since that time, the value of CAD has fallen about 25% against USD.

Thus, if you had invested in a product that was hedged to CAD (i.e., protected you against the fall in the valuation of the underlying investments’ currency – USD), then it’s only reasonable to expect that when the opposite occurred (rise in USD vs. CAD), the hedged product would do poorer than the unhedged product. It’s actually done what it was designed to do.

Put a different way, over the past 5 years, unit holders of VFV have enjoyed a rise in valuation due to BOTH the rise in the share prices of the underlying S&P 500 stocks AND a rise in USD vs. CAD (since they purchased their US shares when CAD was near on par with USD). On the other hand, unit holders of VSP have only participated in the rise in share prices of the underlying securities.

Of course, the reverse could happen over the next 5 years. It’s only with the benefit of hindsight that we know whether hedging is “worth it”. However, as mentioned above, if you’re investing for the long term and buying small amounts frequently over that time, I’d argue that you are already “hedging” since currencies are fluctuating for both good and bad over your entire investing life.

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