Shopping trips to the United States are a Canadian ritual. Better selection, lower prices, and the thrill of bargain hunting keep us going back for more. However, merchandise is not the only thing worth buying south of the border. Equities listed on U.S. stock exchanges should also be on the shopping list of every Canadian investor. The reason? U.S. stocks in Canadian portfolios help reduce investment risk in a number of ways.
More than 70 per cent of the stocks in the S&P/TSX 60 Index, the benchmark index of large-capitalization companies on the Toronto Stock Exchange, belong to the financials, energy and materials sectors. Consequently, investing only in TSX-listed stocks is bound to result in a portfolio that is overly concentrated in these areas. To appreciate what this could mean to your portfolio, look no further than return rates during the first six months of 2013, a time period when materials prices dropped significantly. The S&P/TSX 60 Index returned –0.97 per cent. Meanwhile, its more diversified U.S. counterpart, the S&P 500 Index, delivered an impressive 13.82-per-cent (U.S.) return rate.
To reduce the risk associated with inadequate sector diversification, Canadians must look outside the country for stocks from industries such as consumer products, information technology and health care, which are all poorly represented on the TSX. For additional geographic diversification, they should also consider investing in foreign stocks from sectors with a reasonable TSX presence. The significant price drop of Canadian telecom stocks when news broke that U.S. telecom giant Verizon Communications Inc. might enter Canada, clearly demonstrates the wisdom of expanding investment horizons internationally.
The logical place to shop for foreign stocks is one of the major U.S. stock exchanges: the New York Stock Exchange and the Nasdaq stock market.
– The U.S. economy is the world's largest and most diversified, so the choice of stocks is among the best on the planet.
– One can get international, not just U.S., diversification because many publicly traded U.S. companies operate globally. In 2011, 46.1 per cent of the production and sales of S&P 500 Index member companies was outside the United States. Furthermore, hundreds of quality companies from around the world are available by purchasing American Depository Receipts on a U.S. stock exchange. An ADR is a certificate that represents ownership of one or more shares or a fractional share of a non-U.S. company.
– U.S.-listed stocks can be traded as easily, and almost as cheaply, as Canadian stocks at most stock brokerages.
Another benefit of owning U.S. stocks is currency diversification. The U.S. dollar is less affected by the price of crude oil than our petrodollar loonie. Being the world's reserve currency, it holds its value better during times of crisis. If the Canadian dollar falls against the U.S. dollar, as Bank of Nova Scotia forecasts for the second half of 2013, U.S. stocks will cushion the blow to Canadian portfolio returns. The relative performance of the two versions of the iShares US Fundamental Index Fund, an ETF designed to track the largest 1,000 U.S.-listed companies by fundamental value, illustrates the effect. CLU is the ETF that is hedged to remove the loonie/greenback exchange rate risk; CLU.C is unhedged. During the first six months of 2013, a time when the Canadian dollar fell about five cents, the unhedged CLU.C returned 23.09 per cent, whereas CLU, the hedged version, yielded 16.51 per cent.
If you choose to invest in stocks directly, following a rigorous method of stock picking such as my approach is key to investing success. If that seems like too much work, buying a mutual fund or ETF is a lower effort way to add U.S. stock exposure to your portfolio. Here are some funds that could do the job.
– TD US Index Fund (TDB217) (Fund reports in U.S. dollars) This un-hedged index mutual fund tracks the Standard & Poor's 500 Total Return Index. It has a MER of 0.54 per cent. The fund is useful for mopping up small amounts of cash in an RRSP because the minimum purchase is only $100 for such accounts.
– Mawer U.S. Equity Fund (MAW108) (Fund reports in Canadian dollars) Mawer is one of the best mutual fund companies in Canada that many retail investors have never heard of. The MER of 1.25 per cent is relatively low for an actively managed fund. The minimum investment is $5,000.
– Horizons S&P 500 Index ETF (HXS-T) (Fund reports in Canadian dollars) This fund is ideal for TFSAs in order to avoid paying non-recoverable U.S. dividend withholding tax. Fees include a 0.15-per-cent MER plus a 0.30-per-cent swap fee for the financial structure. As of April 1, the fund stopped hedging its currency risk and a U.S. dollar version, HXS.U-T, was launched.
– Schwab US Large-Cap ETF (SCHX-N) (Fund reports in U.S. dollars) For low cost, it is hard to beat this U.S.-listed fund which has a rock-bottom MER of 0.04 per cent. It tracks the Dow Jones U.S. Large-Cap Total Stock Market Total Return Index of about the largest 750 U.S. stocks.
– Vanguard Dividend Appreciation ETF (VIG-N) (Fund reports in U.S. dollars) If you want U.S. dividend-paying companies, this ETF is a good choice because the companies it holds increase their dividends regularly. The MER is just 0.10 per cent.
Return Rate, per cent (as of June 30, 2013)
Mawer U.S. Equity Fund (Cdn. dollars)
TD U.S. Index Fund (U.S. dollars)
Horizons S&P 500 Index ETF (Cdn. dollars)
Schwab U.S. Large-Cap ETF (U.S. dollars)
Vanguard Dividend Appreciation ETF (U.S. dollars)
Ms. Bebee has some investments in the TD US Index Fund (US$) and Vanguard Dividend Appreciation ETF.
Ms. Bebee is Canada's independent voice on personal finance and author of No Hype – The Straight Goods on Investing Your Money, a popular book of investing basics for Canadians from a financial industry outsider viewpoint. Through her writing, speaking and teaching, Gail shows people how to take control of their money and achieve their financial goals. Her column will appear monthly on the Financial Road Map site. Her website is www.gailbebee.com