Investing in the U.S. equity and bond markets allows Canadians to diversify their capital and lower overall risks. Several growth stocks trading south of the border also provide Canadians an enticing opportunity to grow long-term wealth and most domestic brokerages will give users access to financial instruments listed on major U.S. exchanges.
The most popular exchanges in the U.S. such as the NYSE and NASDAQ have close to 6,000 stocks listed which is twice the number compared to Canadian exchanges that include TSX and TSXV.
The United States is the world’s largest economy and gives investors access to Dividend Kings (these are companies with 50 consecutive years of dividend growth) as well as tech heavyweights including Apple, Facebook, Microsoft, Amazon, and much more.
However, if you are looking to add U.S. stocks to your portfolio, there is a major factor that needs to be considered, related to foreign exchange conversion fees. And this is where Norbert’s Gambit comes into play.
A currency conversion technique, Norbert’s Gambit allows low-cost conversion of the CAD/USD currency pair via a discount brokerage platform. This technique helps Canadian investors avoid high currency conversion fees when buying inter-listed equities or dual-listed instruments that trade both on the TSX as well as U.S. exchanges.
Why is Norbert’s Gambit essential for investors?
Norbert’s Gambit was developed by Norbert Schlenker in 2001 for his personal use. Generally, when you buy U.S-listed stocks on Canadian discount brokerages such as Wealthsimple Trade or Questrade you will be levied with a currency conversion fee. Questrade’s fees range between 1.5% and 2% while Wealthsimple Trade charges 1.5%. For example, if you invest $10,000 in U.S. stocks, total conversion fees will be between $150 and $200.
U.S.-listed exchange-traded funds or ETFs are one of the most tax-efficient ways to invest in foreign instruments and hold them in your RRSP (registered retirement savings plan) account. However, these ETFs need to be bought and sold in foreign currencies which involves exchanging the loonie for the greenback. But as stated above the Norbert’s Gambit allows you to lower these costs and the same will be discussed here.
It's important to understand the FX rates before you opt for Norbert’s Gambit. In case you call your bank or your broker and ask for a currency quote to convert CAD to the USD, the response will be a number close to 1.24. It means the financial institutions will pay you 1 USD for every 1.24 CAD.
Its also represented by USD/CAD = 1.24. Here, USD is the base currency and CAD is the quoted currency. So, in case you want to sell $25,000 CAD in exchange for USD, you will receive $25,000/1.24 which is equal to $20,161.29 USD. However, you will receive less than this amount as the broker will charge a conversion fee as discussed above.
Norbert’s Gambit with the Horizons US Dollar Currency ETF
One of the easiest ways to perform the Norbert’s Gambit is with the Horizons US Dollar Currency ETF which is the equivalent of holding USD in your account. The ETF is available in two versions, both of which trade on the TSX. The first trades under the ticker symbol DLR which is bought and sold in CAD. The other version is the DLR.U which traded in the USD.
The two versions trade close to $10 per unit and the difference in the price between the DLR and DLR.U is the current exchange rate. These ETFs can be used to exchange CAD for the USD and the proceeds can then be leveraged to buy stocks or ETFs on the U.S. stock market.
Let’s start by assuming that you aim to convert CA$25,000 including commissions to buy a U.S.-listed fund for your RRSP such as the FXAIX.
When you are purchasing the DLR, you need to look at its ask price which is around $12.46. If we account for a commission of $10, we can purchase 2,005.61 shares given this calculation- ($25,000-$10)/$12.46.
Now, you need to get a quote for the DLR.U which is US$10.08. So, if you are interested in selling DLR.U you should expect to receive US$10.08 per unit. You then need to place an order to sell 2,005.61 shares and expect to receive US$20,216.54 for the transaction. After accounting for a $9.99 commission, net proceeds will be US$20,206.54.
We have successfully converted CA$25,000 to US$20,216.64, indicating a conversion rate of 1.236. After accounting for conversion fees, the current spot rate is closer to 1.24. Now, if we calculate the transaction costs it amounts to $38 which is less than 0.18% of the total transaction value, resulting in massive savings for the investor.
For example, a discount broker would have charged at least $375 as conversion fees which means you saved around $337 here. You can use the US$20,206.64 to buy 139 shares of the FXAIX ETF which is currently trading at $145/unit in your RRSP.
The trades take three business days to get settled after which you will be able to transfer the CAD to USD at a minimal cost. You can also use Norbert’s Gambit technique with stocks that are traded on both the TSX and the NYSE such as the Royal Bank of Canada and Shopify.
What are the cons of Norbert’s Gambit?
- The Norbert’s Gambit is ideal for high-value trades and it does not make sense for investment amounts of less than $10,000. Basically, you need to look at the broker commissions and take a call.
- In case you are executing a short sale, you need to ideally do it before the buy to avoid associated roadblocks. In case the currency markets are volatile, the rates displayed on the broker platform may significantly vary compared to the spot rate.
- You need to consider factors such as a long weekend or the holiday period as trading is generally low on these days resulting in higher bid-ask spreads.
- Investors need to avoid purchasing stocks that pay a dividend just before their ex-dividend dates as you might receive a payout that is part of your taxable income but the dividends going out of your account is not tax-deductible.