Sunday, July 11, 2010

International Trading and Currency Risks

A reader wanted to know the name of the broker that I use to buy securities on the Toronto exchange. I use Fidelity, but some other online brokers have this service also. More information about international trading at Fidelity can be found at Fidelity Investments.

I have limited my purchases to securities trading on the Toronto exchange so far. The commission is $19 Canadian. The symbols used for trading are different than the ones that I have referenced in previous posts which originate from Yahoo Finance. At Fidelity, the symbol for the Claymore ETF for 1-5 year Canadian Government bonds is CLF:CA. I have bought 400 shares of that ETF with part of my Canadian dollar position. BOUGHT 200 CLF:TO AT 20.20 CAD Added 100 CLF:TO-Sold 100 CPD:TO Sold HSE:TO at 30.48 CAD/Bought 100 of ETF CLF:TO at 20.10 CAD

I also own the Claymore ETF for 1-5 Year Canadian Corporate Bonds, and the Fidelity symbol is CBO:CA (CBO.TO at YF). Bought 100 CBO:TO at 20.4 & 100 CPD:TO at 16.09 By buying these and other securities on the Toronto exchange, I receive my dividend payments in Canadian dollars after a 15% withholding tax. This tax is paid irrespective of whether I buy the security on the Toronto exchange or the ADR on a U.S. exchange using U.S. dollars. If I buy the ADR using USD, I will receive the dividends paid in Canadian dollars in USDs after a conversion at the then prevailing exchange rate. Since I am a long term holder of CADs, capable of holding them for as long as I live, I prefer to receive the dividends in CADs to increase my position in this currency over time.

I am exposed to currency risk irrespective of whether I buy the ADR or the original shares on the Canadian market. I do not believe that most individuals understand the currency risk issue when they buy non-hedged international stock or bond funds, or individual foreign stocks and bonds. I do not avoid that risk by buying NYSE listed ADRs.

In several prior posts, I show how the ADRs track the share price of the original shares in the main foreign exchange for the company. I used several examples, including ADRs for companies based in France, Switzerland and Australia. Bought 100 AXAHY at 14.69 (EURO) ADDED 50 NABZY AT 19.51 (National Australia Bank (AUSTRALIAN DOLLAR); Added 70 RHHBY at 34.07-Completing Round Lot/ Swiss Franc-Euro (SWISS FRANC); Bought 100 NVS at 49.08 (SWISS FRANC); see also, Strong U.S. Dollar + Weak Market=Time to Start Looking Overseas).

I recently bought an ADR for Manulife (MFC). Bought 100 MFC at $15.05 I could have bought shares on the Toronto exchange, but elected to buy the ADR. I wanted to use my CADs to buy more of the Canadian Government bond ETF. I will receive dividends for MFC in U.S. dollars after conversion from the Canadian currency and the 15% reduction for the Canadian tax. (I let TurboTax deal with the foreign tax credit issue). But the price of my ADR shares will be linked to the ordinary share price in Toronto adjusted for currency exchange.

I wanted to highlight the currency issue for MFC which I did not discuss when I purchased shares. To do this comparison, I will take the price of MFC at a time when the Canadian dollar was weak compared to the USD. I pulled up a long term Chart of FXC, the currency ETF of the Canadian Dollar, and I see some weakness on 3/2/2009. I then pulled up a chart on the ADR MFC and found a USD price of $7.49 Chart The price close Friday at $15.31 for a gain of about 104%. The Canadian shares closed 3/2/09 at 9.65, MFC.TO, and at 15.8 last Friday for a gain of almost 64%. The difference between the ADR and ordinary share appreciation, which is very large, is the currency exchange factor, as the CAD has rallied against the USD since 3/2/09. The Canadian dollar will buy $.9674 on 7/9/2010, whereas it would buy only $ .7769 on 3/2/2009: CAD/USD Chart Until an investor understands the currency risk completely, they are unable to evaluate the risk and whether or not they want to assume it.

Now, I could have reached the same result as buying the ADR MFC by converting my USDs into Canadian dollars when the USD was strong on 3/2/09 and then buying MFC on the Toronto exchange. Then if I sold those ordinary shares, and converted the proceeds back into USDs, I would have received the same appreciation on the shares as the Canadian buyer on the Toronto exchange plus the currency appreciation of the CAD vs. the USD, minus the fees for converting both ways which would eat into the overall return some. Those fees are one reason to keep my CADs in Canadian dollars and to take my dividends and interest payments from Canadian securities in Canadian dollars.

Possibly, I would consider converting them back when and if 1 CAD would buy $1.25 USD. Otherwise, I am satisfied in trying to earn some kind of return on my long term CAD position.

For many individual investors, purchase of the ADR will be a satisfactory option for foreign stock exposure. I recently bought ADRs for Roche, Novartis, and Sanofi. A large institutional investor wanting to buy Roche shares would most likely look to acquire those shares in Zurich due to liquidity considerations. The Roche ADRs trade on the pink sheet exchange in the U.S. with relatively low volume. RHHBY Roche Holding Ltd: Also I do not believe Zurich is one of the 8 foreign exchanges where I can place trades. Otherwise, I would consider buying Swiss Francs to make purchases in Switzerland. I am more willing to accept currency risk from owning shares priced in Swiss Francs, Australian Dollars, Norwegian Krone, and Canadian Dollars, than any other developed market currency. But, I am not going to overdue it anywhere outside the U.S. due to currency risk considerations among other reasons. Most of my assets (90+%) are in USDs. I just do not want 100% in USD.

One reason that I bought the Claymore Canadian ETFs on the Toronto exchange is the transparency, volume and the low bid/ask spread. When I bought the shares of CLF:TO (CLF:CA at Fidelity) on Friday, the bid was 20.19 and the ask was 20.21. I placed a limit order to buy 200 at 20.20 which was immediately filled. My alternative was to purchase this security on the U.S. Grey Market using USDs. I would assume that any U.S. based broker allows for trades to be placed on the pink sheet market in its various forms: OTC Market Tiers, OTCQX, Pink Quote/OTCBB, OTCBB, Pink Sheets, Grey Market, Caveat Emptor

I prefer to avoid the Grey Market unless I want to buy a security and have no other choice. There is no transparency. There is either no volume or immaterial volume on most of the securities traded in the Grey Market. The bid/ask is not even displayed. There are no market makers, and no rules to speak of as far as I can tell. Forget about best order execution in the Grey Market. I have seen buy orders for a security filled at $15.5 when I was trying to buy at $16 and was not filled. Limit orders are therefore essential, and I would have to convert the Canadian price into U.S. dollars to even have an idea of where to place my limit order.

For example, CLF:TO closed Friday at 20.21: CLF.TO: Summary for CLAYMORE 1-5 YR LADDER GOV T BONDS. The Grey Market price for this security was $19.3341 with the last trade on 7/6/2010: CLFMF Claymore 1-5 Year Laddered Government Bond ETF: Summary As of 7/6/2010, the equivalent price in CADS would be around 20.40 CAD for $19.33 USD. Currency Converter

I would have to do a different calculation to know where to place my limit price for CLFMF on Monday. I would have to take the exchange rate at the time of my bid using the current share price information of the shares traded in Toronto. On Sunday, 7/11, using the closing prices of the shares on Friday of 20.21 CAD, and the current exchange rate, the equivalent price would be $19.58 USD. Currency Converter This will change on Monday some as the price of the Toronto shares change as well as the conversion rate. But after doing all of that work, and doing it right, I will most likely not receive a fill of an order in the U.S. Grey Market. So, most of the time, I do not bother with it.

For the shares that I have purchased on the Toronto exchange, Fidelity will show me the value in both Canadian dollars and U.S. dollars. The Canadian dollar price is from the Toronto exchange. It would not be unusual to see a fall in price in Canadian currency and a rise in the USD value or vice versa. This is a real time lesson in currency risk that an owner of the ADR will not see until they put pen to paper and do the calculations. The risk is still there for the ADR but is not graphically displayed in the same manner.