Sometimes, the reverse effect happens. In 2016, from the beginning of the year until the end of April, VOO totaled a gain of 1% while VFV totaled a loss of -8%, 9% less!
Obviously, the impact of currency fluctuations can be pretty significant on the returns of foreign investments.
Many ETF providers offer currency-hedged versions of their international funds to remove the impact of currency fluctuations on returns. How effective is this hedging?
Interestingly, Vanguard Canada provides two ETF wrappers around VOO, one with currency hedging (VSP), and one without (VFV). Given that they now have a little over four years of existence, we can look at their track record. Here's a chart of:
- S&P 500 in Canadian dollars, currency-hedged: VSP (in blue),
- S&P 500 in Canadian dollars, no currency hedging: VFV (in red), and
- S&P 500 in U.S. dollars: VOO (in orange).
Source: PortfolioVisulalizer
Over this period, VFV was able to deliver an impressive annualized return of 22.83% while VSP and VOO delivered more modest annualized returns of 14.35% and 14.89%, respectively. One could attribute the small difference in returns of approximately 50 basis points between VSP and VOO to three things:
- The 15% U.S. withholding tax on VUS dividends,
- the higher MER, and
- the cost/impact of currency hedging.
To investigate this, I've decided to give a look at another S&P 500 ETF with a longer history: XSP. Here's a comparison of VSP and XSP:
- S&P 500 in Canadian dollars, currency-hedged: VSP (in blue), and
- S&P 500 in Canadian dollars, currency-hedged: XSP (in red).
Source: PortfolioVisulalizer
Let's call this a perfect match.
As VOO is younger than XSP, I'll use the mutual fund version of Vanguard's S&P 500 (VFIAX), instead, to get the longest possible comparison. But, we must be careful. Before november 15, 2005, XSP did not provide currency hedging. So, we'll limit our comparison to the period after the change. Here's the result:
- S&P 500 in Canadian dollars, currency-hedged: XSP (in blue), and
- S&P 500 in U.S. dollars: VFIAX (in red).
Source: PortfolioVisulalizer
Over the period, VFIAX delivered an annualized return of 8.07% while XSP provided an annualized return of 6.40%. That's a pretty significant difference, not entirely explainable by the the 15% withholding tax on dividends, the higher MER, and the cost of hedging.
But, it's hard to see where the problem was on the growth chart.
[To be continued...]