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  1. What factors must I consider? I know the exchange rate, exchange rate conversion cost, and Level 1 withholding tax.

  2. How do I factor them? What are the formulas? I know that I can't predict the future exchange rate but I just want to know confidence interval.

For Canadian traded ETF for US Small Caps, I know just XSMC iShares S&P U.S. Small-Cap Index ETF. Its MER is .2%.

US-traded ETFs have cheaper MER.

.04% SCHA Schwab U.S. Small-Cap ETF

.05% VB Vanguard US Small-Cap ETF

.07% IJR iShares Core S&P Small-Cap ETF

.10% VIOO S&P Small-Cap 600 ETF

.10% VTWO Vanguard Russell 2000 ETF

.19% iShares Russell 2000 ETF

For Canadian traded ETF for US Mid Caps, I know just XMC iShares S&P U.S. Mid-Cap Index ETF. ETFdb.com

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  • IShares Canada XSU is by far the largest US small cap etf. The XSMC and its currency hedged counterpart XSMH were both very recent additions (Sept 2019 inception) and remain small. XSU is currency hedged and has an MER of about 0.35 owing to the extra cost of the currency hedge.
    – not-nick
    Dec 23, 2019 at 5:41

2 Answers 2

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U.S. ETFs have a cheaper MER because for the canadian version of the fund the foreign withholding tax gets rolled into the MER. Canadian Couch Potato did a piece on this in regards to Vanguard index funds. He concludes that you're better off holding US based equities in your RRSP (since RRSPs aren't subject to foreign withholding taxes), but in TFSAs and non-registered accounts you're better off having the Canadian based fund since the currency exchange cost, and foreign withholding cost make purchasing the US based ETF less cost-efficient.

Alternatively you could attempt to employ Norbert's Gambit to avoid the currency conversion costs, but you'd still be facing the withholding taxes.

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I know that I can't predict the future exchange rate but I just want to know confidence interval.

You seem to be misunderstanding how exchange rate affects stock funds / ETFs.

If you buy a US index, let's say S&P 500, the values of the stocks are measured in US dollars. Buy a US S&P 500 fund, and the value of the fund is measured in USD. Buy a Canadian S&P 500 fund, and the value of the fund is measured in canadian dollars.

But that doesn't change the fact that the underlying securities are fundamentally USD-based securities. So, if USD weakens, the US S&P 500 fund loses its value, as measured in Canadian dollars, exactly as much as the Canadian S&P 500 fund does.

That happens if you buy only funds that do not have any kind of exchange rate hedging.

However, buying a stock fund that has exchange rate hedging would be a terrible idea. The reasoning is that stocks are already protected against exchange rate changes.

Consider for example a US company, part of S&P 500, that sells its products to US and international markets. Now the USD weakens. The international companies the S&P 500 constituent company competes against have to raise prices in the local market, and the S&P 500 constituent company finds it easier to sell its products in the international market due to a weakened dollar. Thus, the company sees increased profits and its stock price rises.

So, in summary: US dollar weakens ⇒ US company stock prices rise. The same argument could be made in the opposite direction. So a Canadian investor sees two effects affecting the fund price, one reducing it (weakening USD) and one increasing it (stock prices rising).

Thus, a stock fund is more or less already protected against exchange rate changes!

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  • I disagree with your assessment of what constitutes a US vs international company and the markets they compete within. e.g. US dollar weakens => US company stock prices rise.
    – paulj
    Dec 23, 2019 at 14:48

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