An index fund for your portfolio’s foreign component

Here’s a fund that checks a number of boxes. It covers off your portfolio’s foreign content, hedges your currency exposure and keeps your costs low.

Index funds that track broad market indexes offer you no hope of exceptional returns beyond what their underlying index provides. But they also offer practically no risk of substantially below-market returns. So if you’re content with market returns year in and year out, these funds can make sense for you.

They can also make sense for you to help cover off the foreign component of your portfolio if you don’t want to spend a lot of time researching U.S. and international stocks.

One index fund we like that gives you broad exposure to the U.S. large-cap market is TD U.S. Index Currency Neutral Fund-e (Fund code: TDB904 (NL)). This fund seeks to achieve results that are similar to the S&P 500 Total Return Index. This index is regarded as the best single gauge of U.S. large-cap equities. It includes 500 leading companies and captures about 80-per-cent coverage of available market capitalization.

To hedge or not to hedge currency?

The fund also seeks to mostly eliminate its foreign-currency exposure. It uses derivative contracts, on an ongoing basis, to achieve this end. Its hedging strategy attempts to protect against losses from declines in the value of the U.S. dollar against the Canadian dollar.

The drawback of this strategy is the fund will not benefit from increases in the value of the U.S. dollar against the Canadian dollar. This, of course, may occur in the short term, as the U.S. currency is frequently regarded as a place to put money in times of exceptional global uncertainty. Then too, the U.S. Federal Reserve is expected to boost interest rates soon, and that too is bullish for the greenback.

On the other hand, we regard the Canadian dollar as undervalued. Moreover, it has the potential to rise if global economic activity picks up and our resources once again enjoy considerable demand. Under these circumstances, a rising loonie would reduce your returns from unhedged U.S. equities.

If you don’t want a currency hedge, then you should consider the unhedged version of the fund (Fund code: TDB902 (NL)). You may want to do this if have a considerable need for U.S. currency, such as vacationing snowbirds do in the winter.

Another thing we like about TD U.S. Index is it has small contribution limits, thus making dollar-cost averaging easy at a time when the U.S. market is arguably somewhat on the expensive side.

The management expense ratio is 0.51 per cent.

TD U.S. Index Fund-e is a buy if you want index-like returns with some foreign-currency protection and you can tolerate medium risk.

Keep costs in mind when choosing an index fund

Since index funds typically try to do the same thing — track the returns of a specific index — there’s not much to distinguish between them except for their expense ratios. That’s why we suggest the e-versions of TD Index funds as your first choice.

These funds are only available through the bank’s online banking or investing arms. And since they’re available only through the internet, TD is able to keep the costs on these funds extra low.

As we said earlier, the hedged version of TD U.S. Index-e has a management expense ratio, or MER, of 0.51 per cent. Its non-hedged version has an even lower MER of 0.35 per cent. By contrast, the retail version of the latter fund has an MER of 0.54 per cent.

But even this MER easily beats those of other big banks. Take CIBC, for instance. The MER of its U.S. index fund is more than twice as high at 1.18 per cent. And the bank doesn’t even offer a currency-neutral version of the fund. Mind you, it does offer a premium class version that charges just 0.39 per cent. But you’ll need a minimum initial investment of $50,000 to invest in this version.

So keep costs in mind when choosing between index funds.

 

Money Reporter, MPL Communications Inc.
133 Richmond St. W., Toronto, On, M5H 3M8, 1-800-804-8846