As a Canadian investor, gaining exposure to large U.S. tech names can be an intimidating process. When investing in U.S. stocks on U.S. exchanges one is exposed to foreign currency (FX) fluctuations, which could benefit or eat into your overall returns. Tax implications also become a problem because investors need to consider both the FX at the time of purchase and sale to correctly calculate their taxable capital gain. Plus, many large tech names trade at prices well beyond reach for small investors, such as shares of Amazon (AMZN: NASDAQ) which cost upward of USD$3,400 for a single share.
At KeyStone, we believe that our clients should not fear investing directly in U.S. listed stocks, as over a 2-10 year holding period, it is nearly impossible to forecast where an exchange rate will go next. Plus, FX fluctuations tend to work themselves out over the long run and there is always the chance that an appreciating U.S. dollar could benefit your investment to the upside. At the very least, holding securities (stocks) in US dollars offers Canadian investors currency diversification.
Having said this, if potential FX fluctuations are keeping you up at night, CIBC and the Canadian NEO exchange now offer a solution. Enter CIBC’s Canadian Depository Receipts (CDRs) – modeled after the American Depository Receipt (ADR) – which is a bank-issued certificate representing shares in a foreign company for trade on Canadian stock exchanges. CDRs are listed in Canadian dollars, so Canadians no longer need to worry about those pesky FX fluctuations and can gain access to large U.S. tech names at a fraction of the price. CDRs also allow investors to avoid conversion fees for converting their Canadian dollars into U.S. dollars. Plus, any dividends that are paid on the CDR reference shares flow through to the Canadian shareholder in Canadian dollars.
We were recently asked by a client, “Why is there a difference between the trading price of Microsoft Shares on the NASDAQ vs. Canadian NEO exchange?” To drive home how a CDR works, here is a simple explanation on why the price difference for Microsoft on both exchanges.
Microsoft (MSFT: NASDAQ) shares on the NASDAQ represent one full share of the company. Whereas Microsoft’s CDR (MSFT: NEO) on the NEO exchange represents a fractional share of Microsoft in Canadian Dollars. For example, by going to CIBC’s website, they have listed a CDR ratio for the Microsoft CDR as 0.05955, which means the CDR on the Canadian exchange represents about 6% of one share in Microsoft. A quick calculation will show you that this is the case. A current share in Microsoft on the NASDAQ is USD$336.04, and 6% of this total share amount is USD$20.01. After converting to Canadian dollars at an exchange rate of approximately CAD$1.25/USD, the Canadian share price is approximately CAD$25.00.
Whether CDRs are right for your portfolio can come down to if you want to avoid FX fluctuations. CDRs are another way of owning large U.S. tech companies at a fraction of the price. At the end of the day, we believe it is generally prudent for Canadian clients to have some exposure to U.S. dollars given the currency’s positive effects on broader diversification for a portfolio.