Some of the lowest-cost ETFs trade on the U.S. stock exchange, forcing cost-conscious Canadian investors to bite the bullet and convert their loonies to dollars (most likely at a less than optimal rate). There are now ETFs and trading strategies available that can help mitigate a portion of the hidden costs of converting Canadian dollars to U.S. dollars.
The Horizons U.S. Dollar Currency ETF (DLR) is an investment vehicle that holds cash and cash equivalents that are denominated in U.S. dollars. It is traded on the TSX and priced and transacted in Canadian dollars.
The Horizons U.S. Dollar Currency ETF (DLR.U) is the exact same investment vehicle as DLR. It holds cash and cash equivalents that are denominated in U.S. dollars and also trades on the TSX. The only difference is that it is priced and transacted in U.S. dollars.
Both DLR and DLR.U have the same International Securities Identification Numbers (ISIN), which is basically the “DNA” of the security. The first two characters “CA” are the country code, the next nine characters “44049C104” are the Committee on Uniform Securities Identification Procedures (CUSIP) number, and the final character “1” is the check digit.
The process of using these two identical securities to convert Canadian dollars to U.S. dollars more cost-efficiently may seem like a daunting task at first, but once you get the hang of it, it’s a cinch.
An investor has $58,140 Canadian dollars that they would like to convert to U.S. dollars in order to purchase the Vanguard Total Stock Market ETF (VTI) within their brokerage account. Their foreign exchange department has just offered them $1.0161 U.S. dollars for each of their Canadian dollars (for a total of $59,076 USD). The investor is not entirely convinced that this is such a good deal for them, and proceeds to use DLR and DLR.U to get a better currency conversion rate. The four steps they would need to take are listed below (*Remember to always use limit orders when placing ETF trades):
Step 1: Buy 6,000 shares of DLR in the Canadian Dollar Account
Since DLR is priced and transacted in Canadian dollars, there will be no forced currency conversion for the purchase of 6,000 shares of DLR on the TSX. If the quoted ask price is $9.69 per share, the total cost in Canadian dollars (excluding commissions) would be $58,140.
Step 2: Sell 6,000 shares of DLR.U in the U.S. dollar account
It may appear as though you are selling a security you don’t have, but remember that DLR and DLR.U are identical securities – the only difference is the currency that their price is quoted and transacted in. It is extremely important that you sell 6,000 shares of DLR.U in your U.S. dollar account (to avoid unintentional currency conversions). DLR.U will show as a short position (i.e. negative 6,000 shares) until the dust settles (approx. trade date + 4 days). If the quoted bid price is $9.91 per share, you should end up with cash proceeds of $59,460 USD (excluding commissions).
By using this method, the investor ends up with $384 additional U.S. dollars in their account ($59,460 - $59,076).
Step 3: Buy 800 shares of VTI in the U.S. dollar account
Since the proceeds from the DLR.U sale will settle on T+3, and the purchase of VTI will also settle on T+3, the trade can be initiated immediately. If the quoted ask price for VTI is $74.325 per share, the total cost would be $59,460 USD (excluding commissions).
Step 4 (T+3): Journal 6,000 shares of DLR in the Canadian dollar account to the U.S. dollar account
Recall that we sold 6,000 shares of DLR.U that the buyer now wants delivered to them – although we don’t own DLR.U, we have something equally as good! We “journal” 6,000 shares of DLR from the Canadian dollar account to the U.S. dollar account in order to settle the sale of DLR.U, keeping the account in good order.
Perhaps as the Canadian ETF market develops, there will be equally comparable products both here and south of the border. Until that time, using DLR and DLR.U is one potential method for lessening the burden of currency conversion costs. For a more intuitive explanation of the process, please refer to the flow chart below.