What is your opinion of investing in Canadian depositary receipts (CDRs) for U.S. companies such as Amazon.com AMZN-Q, Nvidia Corp. NVDA-Q and Microsoft Corp. MSFT-Q, as opposed to investing in the U.S. stocks directly?
Like most investing products, CDRs have their pros and cons.
The big advantage of CDRs is that you can buy them in Canadian dollars, which spares you from paying the steep foreign exchange costs that brokers charge for converting your loonies into greenbacks. CDRs are also currency-hedged, which means the value of your investment should be insulated, at least to an extent, from fluctuations in the Canada-U.S. exchange rate.
Another benefit of CDRs is that, because they trade at much lower prices than their respective U.S. stocks, it’s easier to invest relatively small sums of money. As an example, say you have $2,000 to invest in Nvidia, whose shares were trading early Friday afternoon at about US$814 on the Nasdaq Stock Market. After taking the exchange rate into account, your $2,000 would buy a maximum one Nvidia share, leaving you with $850 in uninvested Canadian cash.
With Nvidia CDRs, on the other hand, you could put virtually all of your money to work. That same $2,000 would buy 26 Nvidia CDRs (NVDA.NE) based on Friday’s trading price of about $76.50 on the NEO Exchange, leaving you with just a few dollars of idle cash (depending on the size of the commission).
Now for the cons.
The main drawback of CDRs is that their returns have lagged, in some cases by a wide margin, the returns of their respective U.S. stocks.
Continuing with Nvidia, for the two years ended March 31, the CDRs posted a gain of 215.5 per cent. That’s a fabulous return, but it’s well short of the 231.1-per-cent gain for Nvidia’s U.S.-listed shares over the same period.
Other CDRs – CIBC World Markets offers more than 50 of them – have also underperformed their U.S.-listed counterparts. Amazon.com’s CDRs, for example, gained 5.9 per cent over the same two-year period, compared with 10.7 per cent for the U.S.-listed shares. Microsoft CDRs rose 32.1 per cent, compared with 36.5 per cent for the shares.
You get the picture.
Why don’t the CDRs keep up with the shares? One reason is that currency hedging isn’t free. In its marketing materials, CIBC says it “earns revenue for providing the notional currency hedge”, which will “on average have a spread of less than 0.5 per cent per year.”
Another reason is that hedging itself isn’t exact. “There can be no assurance that the notional FX hedge mechanics applied in respect of the CDRs will achieve the desired objectives,” CIBC says in a prospectus for an offering of CDRs.
“Furthermore, tracking difference between the price performance of a series of CDRs and the price performance of the applicable underlying shares may arise for a number of reasons,” it said. These include differences between Canadian and U.S. short-term interest rates and the level of currency and equity volatility.
Taking all of these factors into account, CIBC says that “purchasers of CDRs should recognize the complexities of purchasing and holding CDRs and should understand that they will not be an exact substitute or hedge for a position or an investment in the related underlying shares.”
In other words, buyer beware.
Another concern I have with CDRs is the expense and difficulty of using them to build a diversified portfolio. If you’re paying a commission each time you buy or sell a CDR, that can add up. What’s more, you’ll need to buy a basket of CDRs to achieve adequate diversification.
A simpler, and less expensive, approach is to invest in a Canadian-listed exchange-traded fund that tracks a broad U.S. index such as the S&P 500. You can do this with one trading commission – or for free if your broker offers zero-commission ETF trades – and achieve superior diversification in the process. As I discussed in my column last week, S&P 500 ETFs are available in both currency-hedged and unhedged versions.
CDRs have their advantages but, given how they have underperformed, you may be better off buying the stocks directly. Or you could save time and money, and reduce your risk, by investing in a broad U.S. ETF that holds all of the U.S. companies that CDRs track, plus hundreds of others.
E-mail your questions to jheinzl@globeandmail.com. I’m not able to respond personally to e-mails but I choose certain questions to answer in my column.