The Canadian Guide to Foreign Dividends

Inspired by the success of my recent write-up on BME European Value Retail, I’ve decided I’m going to work in more analysis of foreign stocks into the CDI newsletter.

Don’t worry, Canadian readers. I’m not going to go nuts with this. Maybe 3-5 articles per year.

There are a few reasons I think it’s a good idea. I believe that North American stocks are becoming somewhat overvalued — especially in the U.S. — which limits my overall hunting ground. I’m not saying every stock is overvalued or we’re in a bubble or anything like that, but I like value. And increasingly, value just can’t be found locally.

Canadian investors generally do a pretty good job diversifying into U.S. stocks, but after that we drop the ball. Besides, I’m not really sure U.S. diversification is such a good move any longer. So many Canadians have taken on a drastically different attitude towards our neighbours. It’s been 6+ months since Trump first targeted Canada with tariffs (and even longer since he started trolling our former Prime Minister), and Canadians are still pretty angry about it. Our travel to the United States is still down significantly.

There are other advantages to creating a true worldwide dividend portfolio. Say you have interest in living outside Canada one day. If your portfolio only has exposure to North America and you end up living in Asia, you run the risk of currencies moving against you. Your expenses would stay the same, but your dividend income would go down in local currency. Diversifying into additional currencies can help here.

There are a lot of Canadian investors — including my buddy Jim — who put a portion of their portfolio into the United States thinking that some day they’d like to winter somewhere south of Scarborough. Jim has officially put his American plans on hold; he’s much more interested in Mexico or Central America now.

It’s also fun, dammit. Searching for cheap stocks in unloved corners of the world is akin to a treasure hunt. You can often find companies that remind you of peers in North America that trade at much cheaper valuations, or pay much higher dividend yields, or have other such advantages.

Canadians can either get this international exposure the easy way or the hard way. The easy way is to simply buy an ex-Canada ETF. The problem is such an ETF generally comes with U.S. exposure, and we may want to avoid that as well. The hard way is to find international securities and buy them individually.

This edition of the newsletter is to help Canadians with an interest in doing just that. Let’s dive in, focusing on how to buy these types of stocks, dividend withholding taxes, and other challenges.

How to buy foreign stocks in Canada

When I wrote about B&M European Value Retail, the overwhelming piece of feedback I got was it’s not easy for Canadian investors to buy shares.

That was frustrating, because I showed in the piece that it wasn’t very hard at all. Shares traded on the OTC (Over the Counter) market, which can be accessed by many Canadian brokerages.

So let’s go over the four ways that Canadians can buy foreign stocks — ranging from the ridiculously easy to medium difficulty to the hard way. But let’s not get too excited here. The hard way isn’t really that hard.

The ridiculously easy way is to buy an ETF. There are a bunch of ex-Canada ETFs out there, but be vigilant. Most of them have significant U.S. exposure. If you want an easy choice without Canadian or U.S. stocks mixed in, check out:

• Vanguard FTSE Developed All Cap Ex North America ETF (TSX:VIU)

• BMO MSCI EAFE Index ETF (TSX:ZEA)

• iShares Core MSCI EAFE IMI Index ETF (TSX:XEF)

• iShares MSCI Min Vol EAFE Index ETF (TSX:XMI)

We’ll spend the rest of our time looking at more active options.

The easiest way to actively buy European, Japanese, or Australian stocks is to stick to ADRs. ADR stands for American Depository Receipt, and it’s a way for foreign companies to list their shares in the U.S. There are hundreds of ADRs, which should be enough to keep most investors busy for a while.

Note: CDRs (Canadian Depository Receipts) are also a thing. They are relatively new and come with some foreign hedging fees, but they’re an option. I wrote about them a few months ago. 

An ADR works like this. Basically, shares are deposited in trust to a bank, which then makes them available to trade. These shares come with no restrictions, either. They come with the same ownership rights as any other type of share. ADRs can trade either on the NYSE, NASDAQ, or the Over the Counter Market. The largest will have their listings on either the NYSE or NASDAQ.

One thing to note is ADRs will sometimes offer a slightly different share structure than the underlying stock. For instance, one Coca-Cola FEMSA (NYSE:KOF) share on the NYSE is the equivalent of buying ten on the Mexico Stock Exchange. So each KOF share represents a larger ownership in the business than the local Mexican shares.

Other than that, analyzing an ADR is virtually the same as analyzing a stock. The company will put out English shareholder materials to keep their American shareholders in the loop, and results will often be translated into USD.

The beauty of ADRs is they adhere to the same securities rules as any other stock governed by American regulators. If you’re buying stocks directly on say the Nigerian exchange, governance/disclosure rules may be much different. And not in your favour, either.

The next-easiest way to add foreign equities to your portfolio is to find a brokerage firm that deals directly with the various stock exchanges around the world. The undisputed leader here is Interactive Brokers, which has long been a favourite for serious investors because of that access, its dirt-cheap currency conversion fees, and low interest rates charged on margin.

Interactive Brokers will allow you to borrow in Yen and then invest in USD. Borrow costs are low, and investors can pocket an almost guaranteed profit simply by putting the proceeds in government bonds. The problem, of course, is guarding against the Yen moving against you and incinerating all your profits. Still, it’s a popular trade.

Interactive Brokers also offers:

• Really cheap trading commissions (but not free)

• They pay good interest rates on your available cash

• Level two quotes are important for those who actively trade

On the negative side, we have:

• A website that is geared towards active traders

• A complex trading platform

• Notoriously lousy service

Be aware that if you’re trading directly on a foreign stock exchange, that exchange may charge you additional fees to do so. France is notorious for this.

If you’re really serious about buying worldwide stocks, you’re going to want an Interactive Brokers account. But for those of us who want to dabble in worldwide stocks, don’t worry. You can get access without having to change brokerages. You just might not be able to get as much access.

Finally, we have a (little) more difficult way to buy foreign stocks. You can utilize most Canadian brokerages to buy stocks on the Over the Counter exchange (OTC).

The process of doing this is just like buying a regular stock. You find the ticker symbol for the name you want to buy, input the data into your bank’s app, and buy away.

There are a few downfalls, but they’re not a huge deal if you’re serious about such things. They include:

• Having to pay currency conversion fees to transfer CAD to USD

  • You could, potentially, use Norbert’s Gambit to save money here

• Liquidity for many OTC names isn’t great. Use limit orders!

• Some Canadian brokerages (Wealthsimple especially) don’t really play in the OTC market

• You can only hold them in a taxable account

• Trading fees can be higher, but are generally reasonable as long as you’re doing the trades yourself and are planning to hold for a while

One important note before we move on. The CRA requires anyone to report foreign holdings of $100K+ via form T1135. So if you’re a baller that can drop six figures on a foreign stock, keep that in mind.

Dividend withholding taxes

Another issue I commonly hear about buying foreign stocks is dividend withholding taxes.

These are taxes that are taken off at the source, to make sure the dividend taxes get paid. I own Mexican airport stocks Grupo Aeroportuario Pacifico (NYSE:PAC) and Grupo Aeroportuario Centro Norte (NYSE:OMAB). Every time I collect a dividend (twice per year with those ones), the Mexican government takes their cut.

It sucks, but the long-term performance takes the sting away.

Generally, Canadians are paying a 15% withholding tax on foreign dividends, and they’ll pay those withholding taxes in their RRSPs and TFSAs, too. The exception is U.S. stocks in their RRSP, those aren’t subject to any withholding taxes.

Related: Where to hold what, my look at which accounts are best for certain kinds of investments.

A few notable exceptions to the 15% withholding tax norm include India (25%) and Turkey (20%). Withholding taxes are also much lower (5% is the norm) if a Canadian is the controlling shareholder of the foreign corporation.

The reason for the flat taxation on dividends is the various tax treaties countries have. Most are happy to standardize these amounts to make sure that foreign shareholders are on a level playing field around the planet. They don’t want to discourage foreign investment, yet want to make sure they still collect some taxes on it.

Withholding taxes are just one part of the taxation story. You can get credit for these withholding taxes when the feds assess how much you owe every April. Or, if you’re in a high tax bracket, you may have to pay additional taxes. The point is the government doesn’t penalize you for owning foreign stocks. Tax rates end up about the same — whether that income comes from Algeria or Zimbabwe.

To claim foreign tax credits, you’ll have to use use form T2209. Tax planning software can be helpful here.

PWC maintains a list of various withholding taxes around the world if you’re so interested. Note the two figures in the dividends category, the first number is the withholding tax if you’re the controlling shareholder. The second is if you’re a minority shareholder.

Risks

I’ve mentioned most of these risks already, but making them extra clear is always helpful.

Currency risk is the big one. You might make 15% per year on a stock in local dollars, but a 10% move in the CAD versus that currency will wipe out most of your gains. The key to avoiding this is to assume any amount transferred into another currency is there for years. That takes the sting out of conversion fees, and it lets you track returns in local currency. You can then transfer foreign currency back to Canadian Dollars by using my handy currency conversion guide above.

The other risk is local regulatory requirements. Most of the developed world has similar securities regulations, but the developing world is a bit of a cluster you-know-what. The simple way to avoid that is to just not bother with the developing world. It’s a good plan, except that’s often where the really interesting stocks are.

An unstable government can send stocks reeling and damage the local economy. Venezuela went from a thriving country to chaos, all within a decade. Turkey and Argentina have massive inflation problems. Don’t think this can’t happen in developed countries, either. If you’re serious about investing worldwide, diversify among different countries.

The bottom line

Trying to find the proverbial diamond in the rough is fun. It doesn’t matter if it’s stocks, baseball players, or obscure biographies to fill my personal library, the thrill of the chase is a worthwhile way to spend some of your leisure time. Even if you don’t add a cheap UK, French, or Japanese stock to the ol’ portfolio, chances are you’ll still learn something

Sure, there are disadvantages. It’s slightly more complicated than just investing in North America. Dividend withholding taxes are a very visible reminder of how the tax man always gets paid. And your friends will try to convince you all of Mexico is uninvestable because of some cartel-related horror story they read off Reddit four years ago.

Do your research, keep bets relatively small, and keep the investments on the more boring side of the risk/reward spectrum, and I think y’all will do fine. Or, better yet, take the really lazy way out and wait for Nelly here to do the research for you. Okay, fine. You twisted my arm. Stay tuned for that.