Wednesday 27 May 2009

Claymore's Emerging Markets ETF (TSX:CWO) - Good and Bad Points

About a month and a half ago, Claymore Canada announced the launch of a new ETF with broad emerging markets equity exposure sold on the TSX under symbol CWO. At the time, Canadian Capitalist posted a brief assessment and so did his readers with excellent comments. With due recognition to CC, here is my summary, along with some extra bits on the currency hedging method used by CWO (my analysis) and investor costs (input from Som Seif, President of Claymore, who was kind enough to respond to my email enquiry).

The Good:
  • broad emerging markets exposure in a Canadian ETF - this is a new thing, though Canadians could have bought Vanguard's emerging markets fund in the US (NYSE: VWO), which is in fact the same thing since CWO's holdings consist 100% of VWO
  • fund is Canadian domiciled, i.e. is a Canadian not a US security, for US tax purposes, which prevents this fund from being subject to US estate taxes for high net worth investors - those with estates of more than c.USD$3.5 million (I wish!) according to PriceWaterhouseCoopers' U.S. Estate Tax Exposure for Canadians (updated April 2009)
  • MER of 0.65% is reasonable considering trading and currency transaction fees, especially those doing regular rebalancing and using a broker who won't allow wash trades or USD in a registered account. Som Seif sent this comparison of a Canadian buying VWO and holding it three years:
    When you buy and sell, you pay 1-1.5% exchange rate spread.

    So, cost to you for buying and then holding for 3 yrs is 1%+3x25bps+1%=2.75%. That's 90bps a year.

    If you do any trading in between the 3 yrs for rebalancing, the cost goes up even more.

The Bad
  • currency hedging in CWO is CAD vs the USD not CAD vs the various currencies of the emerging markets countries starting with India (19% of the portfolio), Brazil (15%), Korea (12%) etc. What Claymore does is called proxy hedging - the USD is used as a proxy / replacement for the basket of CWO's currencies on the supposition that as goes the USD, so goes the basket. The reason for doing proxy hedging is that few world currencies are liquid enough to easily and cheaply hedge. Som Seif says it works, but being ever the skeptic, I took a closer look, using the top ten countries which comprise 90% of CWO as my sample. My simple analysis in the chart below suggests that over the last 1-year and 3-year periods, the USD and the CWO currencies have not gone up and down together against the CAD. In fact, the CWO currencies as a whole have hardly changed at all vs the CAD, suggesting that hedging isn't necessary at all! Individual currencies have had big shifts but they have almost completely cancelled each other out. Meanwhile the USD has had much larger swings. Granted, this is a short time period so CAD might gain against the emerging world for the next twenty years, and reduce the CAD value of those foreign holdings as a result, which would make hedging worthwhile. But hedging USD vs CAD seems to be a poor way to hedge VWO. CWO's tracking errors against the MSCI index it is supposed to mirror are likely to be very large.


Canadian Capitalist said...

Thanks for the link. One more point I'd add regarding the costs is that hedging seems to be pretty expensive (the costs other than extra management fees show up in the tracking error). The short history of currency-hedged funds shows that these funds have additional costs of at least 1% in the form of tracking error.

Charles said...

I'd be really interested to see the same comparison done as a long term graph (5-10 years) to gauge the volatility of the currency basket versus the Canadian dollar and the USD.

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