Canadian Depositary Receipts: A Breakdown

Amid an uncertain economic environment and an unpopular federal government (on both sides of the border), many of you reading are at least considering moving some of your portfolio to the United States.

If there is a prolonged trade war between Canada and the United States, it seems obvious that Canada will be impacted more than the United States. Canada can — and should — hit back pretty hard if the oft-threatened tariffs actually happen, but the numbers prove it. Canada sells more stuff to the United States than America sells to us, therefore tariffs hurt us more.

There are a few problems with abandoning Canada as an investment today, but we’ll just talk about one. Nobody wants to convert their Canadian Dollars to U.S. ones when the exchange rate isn’t in Canada’s favour. Our dollars have way less buying power in Greenbacks today than they have for most any point in the last 20 years.

There’s a solution to this problem, in a product that allows Canadian investors to buy U.S. stocks on the Toronto Stock Exchange, with Canadian Dollars. They’re called Canadian Depositary Receipts, and they exist for dozens of different stocks.

Let’s take a closer look.

Which stocks can you buy?

The Canadian Depositary Receipt (CDR from now on) game is pretty much controlled by CIBC.

BMO has dipped a toe into the business, with a half-dozen CDRs trading in Canada in early February. Knowing that CIBC has wrapped up the U.S. part of this business, Bank of Montreal went a different direction. It’s going to focus on Japanese and European stocks, launching with names such as Nintendo, Nestle, Mercedes Benz, and Toyota. There will be likely be more coming too, based on demand.

CIBC, meanwhile, has added dozens of different U.S. stocks to their inventory of CDRs. There are 70 altogether, including a smattering of European stocks in there. Here’s a list of 20 that I think are of interest, and you can view the entire list here. I’ll list these with the ticker symbol on the TSX.

• Alphabet (TSX:GOOG)

• Amazon (TSX:AMZN)

• Apple (TSX:APPL)

• Berkshire Hathaway (TSX:BRK)

• Caterpillar (TSX:CATR)

• Coca-Cola (TSX:COLA)

• Costco (TSX:COST)

• Exxon Mobil (TSX:XOM)

• Home Depot (TSX:HD)

• Johnson & Johnson (TSX:JNJ)

• Lululemon (TSX:LULU)

• McDonalds (TSX:MCDS)

• Meta (TSX:META)

• Microsoft (TSX:MSFT)

• Netflix (TSX:NFLX)

• Nike (TSX:NKE)

• Nvidia (TSX:NVDA)

• Starbucks (TSX:SBUX)

• Tesla (TSX:TSLA)

• Walmart (TSX:WMT)

I’m missing a bunch from that list, but you get the point. The list is dominated by the largest stocks on the S&P 500. Since they’re the most popular and have the most demand, this only makes sense.

(We’ll also notice that most CDRs have the same ticker as their U.S.-listed counterparts. I believe this partially exists because it makes remembering the ticker symbol easier, but mostly exists to fool naive investors who think they’re buying a Canadian-listed version of the stock. As we’ll see, there are some differences between the CDR and the actual underlying stock)

There’s enough there to build a pretty diverse portfolio — if you chose to go the entire CDR route — and it’s quite easy to get a little exposure to the U.S. this way. And although CDRs aren’t nearly as liquid as their U.S. counterparts, they offer enough liquidity that most anyone reading this can easily get in and out of positions.

How exactly do they work?

A CDR has two components. They consist of ownership of the underlying stock, plus a currency hedging component.

That second point is really important, because that’s how the CDR issuer (in this case, CIBC), makes money.

Let’s use a real-life CDR as an example. As I type this, the Walmart CDR trades for $42.75 per unit, a far cry below Walmart’s existing price on the NYSE. That’s closer to US$100 per share.

Already we can tell that each CDR isn’t equivalent to one share. In this case, each CDR works out to approximately 0.3 Walmart shares. And, unlike U.S. ADRs, this ratio doesn’t stay the same all the time.

Basically, what happens is this. Instead of currency moves impacting the price of the underlying stock, CIBC — or BMO for their products — adjusts the ratio depending on what the exchange rate does. If the exchange rate works in the Canadian investor’s favour, CIBC dials back the ratio to hedge out the currency. It does the opposite if the Canadian Dollar strengthens.

Hedging the currency has a cost, and that cost is passed onto investors. There is no fixed fee, however, CIBC tells investors that the cost to maintain the currency hedge is “up to 0.60% per year”, which is a reasonable proxy of where the management fee will be going forward.

Advantages to CDRs

There are two big advantages to putting your cash to work in CDRs.

The first is being able to buy shares of the finest U.S. companies without converting currencies. Although there are ways to convert Canadian Dollars cheaply into U.S. Dollars, various brokerages are closing those loopholes.

Norbert’s Gambit is the most popular way of converting. That’s where an investor buys a security in Canadian Dollars, journals it over to their U.S. Dollar account, and then sells it in U.S. Dollars. The only fee paid is two brokerage commissions, and is generally much cheaper than letting the brokerage handle the conversion.

(These days, most investors use the Global X USD ETF [TSX:DLC] to do Norbert’s Gambit. They buy the Canadian version of the ETF and then convert it to the USD version [TSX:DLC.u]. This eliminates the fluctuations caused by buying a stock that is inter-listed in both Toronto and New York.)

A major source of brokerage revenues is converting currency, so it’s little wonder why various brokers are making Norbert’s Gambit more expensive and harder to do. For instance, Questrade will no longer let you do it, and my new broker, Wealthsimple, won’t let you do it either.

CDRs eliminate all the work in doing Norbert’s Gambit, and for certain investors there may be value in that.

The other advantage is CDRs allow investors to get exposure to the underlying stock without having to buy an entire share. For instance, the Walmart CDR is the equivalent of 0.3 Walmart shares. This allows an investor to get exposure to Walmart for as little as $42.75 per share, rather than paying nearly US$100 for a share on the NYSE.

Yes, fractional shares make this moot, but many Canadians buy and sell stocks through brokerages that don’t offer fractional trading.

Disadvantages to CDRs

Let’s look a little more closely at the disadvantages to using CDRs as a portfolio tool.

The first one is really obvious — currency hedging costs money, and that cost is passed onto the investor. 0.6% doesn’t sound like a lot, but it really adds up over time. Over a decade, 0.6% compounded ends up being worth 6%.

Even if you exchange currencies at the going 2% rate (which can easily be beaten), you’ll end up ahead over the long-term to exchange once and keep that currency.

Having a cache of U.S. Dollars isn’t a bad thing, either. They can be used to help pay for U.S. Dollar expenses — like the baseball train trip your author has planned for the U.S. in the spring. Or they can be reinvested into additional U.S. stocks, which then generate U.S. Dollar dividends.

The U.S. Dollar is the reserve currency of the world. Having some assets in that currency is not such a bad idea.

Besides, for the last 10 years, hedging the currency on your USD investments would’ve been a bad move. I’m not sure what the next decade will bring, but it’s very possible that hedging will continue to be a poor decision.

By hedging, you’re taking currency out of the equation. Sometimes, that works to your advantage. And sometimes it doesn’t. By hedging, you’ve guaranteed you won’t get that upside. But you’ve also guaranteed that you won’t get hit by the downside.

The bottom line

Your author isn’t a huge fan of CDRs. I’d much rather own the underlying U.S. stock, especially since converting currencies doesn’t have to be challenging or very expensive.

I take what I think is a fairly pragmatic approach to currencies. When a currency is flirting with a multi-decade low (as the Canadian Dollar is doing today, at least against the USD), then I look to bring Canadian Dollars home. And when my local currency is strong versus the USD, I’m looking to send dollars back across the border and put them to work in U.S. stocks.

CDRs give me exposure to U.S. stocks, but without the currency flexibility. And having to pay 0.60% per year for that privilege? No thanks.

One more thing

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