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The ETF Lab
ETF Spotlight: Tax optimization using Canadian-listed ETFs
Accessing US-domiciled ETFs is relatively easy and can often come with very low expense ratios and high levels of secondary market liquidity. However, there are meaningful tax, exposure and currency considerations for Canadian investors to consider.
Below is a summary table of popular US-listed ETFs and Canadian-listed alternatives from Mackenzie Investments. In this week’s spotlight, we delve into three reasons why Canadian advisors may want to consider using Canadian-listed ETFs in their client portfolios.
Source: Bloomberg, Mackenzie Investments
1. Mitigating US withholding taxes on ETF positions
Why do foreign withholding taxes matter for ETF investors?
ETFs can provide cost-effective exposure to global bonds and/or stocks. However, Canadian investors should be aware of the withholding tax that can occur in some situations.
Most countries levy a tax on dividends paid to foreign investors; for instance, the US government levies a 15% withholding tax on distributions paid to taxable Canadian investors.
Investors receive distributions after the withholding tax has been applied, thus this impact can often go unnoticed.
Canadian investors purchasing ETFs that invest in non-domestic equities or bonds should consider this withholding tax impact along with other cost considerations like management fees and trading expenses.
For a more detailed look into this impact, see our white papers on this topic:
Minimizing this tax drag
The amount of withholding taxes payable will generally depend on two factors:
- The fund/ETF structure
- The account type (TFSA/Taxable account/RRSP) that the ETF/fund is held in
When investing in international securities, Canadian ETF investors generally have three structures available to them:
- A US-listed ETF that invests in international stocks or bonds
- A Canadian-listed ETF that holds US-listed ETFs which invests internationally
- A Canadian-listed ETF that invests directly in international securities
An illustrative example: EM debt
As an example, consider EM debt ETFs. Here, the withholding tax is first applied by the country the bond originates from. After this first level of withholding tax is applied, the US applies an additional withholding tax on distributions made by the US-listed ETF to Canadian investors.
In contrast, QEBH - (Mackenzie Emerging Markets Bond Index ETF (CAD-Hedged)) holds the underlying bonds directly, resulting in one less layer of unrecoverable foreign withholding taxes across all account types (see example below).
Source: Bloomberg, Mackenzie Investments; as of July 31, 2023; additional withholding tax is estimated by taking 15% from the trailing 12MTH yield x $10,000,000 (and adjusted for holding period). * Please note this is for demonstration purposes only. Actual tax amounts will depend on the individual. This should not be construed to be legal or tax advice, as each client’s situation is different. Please consult your own legal and tax advisor.
2. For Canadians, by Canadians
US-listed ETFs are constructed first and foremost with US investors in mind. For instance, several large ETFs aiming to provide ‘international’ equity exposure may have a significant allocation to Canadian stocks, thereby duplicating the allocation Canadian investors likely already have through other funds and/or ETFs. In contrast, ETFs like QDX - (Mackenzie International Equity Index ETF) provide true international (ex-North America) exposure for Canadian investors.
3. CAD-hedged currency options
Another benefit of using Canadian-listed ETFs is the availability of CAD-hedged ETFs, particularly on the global bond side. Most index ETFs in Canada that provide exposure to non-domestic fixed income assets are hedged. This is because, when buying fixed income, investors generally tend to expect lower returns but higher certainties on the outcome, when compared to equities.
For more on CAD-hedged ETFs, see our article: How and when should you use Canadian-Hedged US equity ETFs?
Concluding thoughts
At Mackenzie Investments, we provide a suite of Canadian-domiciled ETFs, engineered in Canada for Canadian advisors and their clients.
Advisors should be aware that some US-listed ETFs may be suboptimal for their Canadian clients due to foreign withholding tax implications, lack of currency hedging options and exposures that are designed for US investors, not Canadian.
ETF News & Notes
Considering real duration vs. nominal duration
In Mackenzie’s most recent podcast, Decoding the Fed's July Meeting: The Outlook for Future Rate Hikes, Dustin Reid, Chief Fixed Income Strategist at Mackenzie Investments, discussed several macro trades he and our fixed income team are focused on in the unconstrained and global fixed income portfolios, including an overweight to real yields, particularly US TIPS.
For pure play exposure to US TIPS, Mackenzie Investments offers QTIP - (Mackenzie US TIPS Index ETF (CAD-Hedged)), which is the largest US TIPS ETF in Canada with around $380M in assets. QTIP has a real yield of 2.07%1, after stripping out the effects of inflation.
QTIP is 100% hedged back to CAD and is domiciled in Canada and thus potentially can achieve a better tax outcome on distributions versus investing in US-listed ETFs.
Source: Mackenzie Investments; as of June 30, 2023
US mega cap dominance
The outperformance from several US mega cap tech stocks YTD has been well documented. The top 10 holdings in US large cap equity indices now represents around 30% of the entire index. Meanwhile, international equities, despite a strong year-to-date from Japanese and European stocks remain less concentrated.
Source: Mackenzie Investments, Bloomberg; as of July 31, 2023; QUU - Mackenzie US Large Cap Equity Index ETF used as a proxy for US equities, QDX - Mackenzie International Equity Index ETF used as a proxy for international equities
For cost effective exposure to international developed ex-North American equities, advisors can consider QDX - (Mackenzie International Equity Index ETF) or the CAD-hedged version (QDXH).
ETF Flows Update
- ETF assets in Canada climbed to a new record of over $387.5 billion with equity ETF inflows outpacing fixed income for the week ending July 28th for the first time since March.
- Canadian short-term bond ETFs saw inflows in July with active ETFs in this category adding $410M in July. With the Canadian yield curve highly inverted, this is a category we’ll continue to watch in the coming months. Mackenzie Investments offers index and active solutions in this category, QSB and MCSB respectively.2
Source: Mackenzie Investments; as of June 30, 2023
Mackenzie ETF Top Performers
Source:
1: Bloomberg; as of July 31, 2023
2: Bloomberg, Mackenzie Investments, National Bank Canadian ETF Flows July 2023; all data as of August 1, 2023, unless otherwise noted
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