The U.S. dollar has now risen to its highest level against the Canadian dollar in more than a decade. This has prompted a member of Pat McKeough’s Inner Circle to ask about hedging against further currency movements, including a fall in the U.S. dollar, by means of this ETF. iShares Core S&P 500 Hedged ETF (CAD-Hedged) holds the stocks in the S&P 500 index, led by top-weighted names like Apple, Berkshire Hathaway, General Electric and Wells Fargo. Pat looks at the pros and cons of the currency hedging feature in this ETF.

Q: Pat: Could you please comment on the iShares Core S&P 500 Hedged ETF (CAD-Hedged) as a good place to park money in order to prevent currency risk? Thank you.

A: iShares Core S&P 500 Hedged ETF (CAD-Hedged) (symbol XSP on Toronto; www.blackrock.com) holds the stocks in the S&P 500 Index, which is comprised of 500 major U.S. stocks chosen by market size, liquidity and industry group.

The index’s 10 highest-weighted stocks are Exxon Mobil, Apple, Berkshire Hathaway, Microsoft, Wells Fargo, General Electric, AT&T, Johnson & Johnson, JPMorgan Chase & Co. and Pfizer. It has a 1.6% dividend yield.

iShares Core S&P 500 Hedged ETF (CAD-Hedged) is hedged against movements of the U.S. dollar against the Canadian dollar. The fund’s Canadian-dollar value rises and falls solely with the movements of the stocks in its portfolio.

Expenses on the units are 0.10% of assets, excluding the cost of currency hedges. Those hedges add costs of 0.13% to the units, for a total of 0.23%. That’s more than double the 0.10% MER on the unhedged iShares Core S&P 500 Index ETF, symbol XUS on Toronto.

ETFs: Investors in this ETF won’t profit from a rise in the U.S. dollar

Of course, the cost of hedging can rise or fall, and cost changes are unrelated to the effect the hedging has on your portfolio. Hedging against changes in the U.S. dollar only works in your favour when the value of the U.S. dollar drops in relation to the Canadian currency. If the U.S. dollar rises while your investment is hedged, it reduces any gain you’d otherwise enjoy, or expands a loss.

Some investors have mixed feeling today about investing in the S&P 500 stocks. They may have a high opinion of many of the major multinational companies in the S&P 500. But they may also fear the U.S. dollar has gone too high in the past few years and is at risk of a downturn. So this ETF may have some appeal.

We see U.S. dollar exposure as a long-term plus—a valuable form of diversification. If you are wary of the possibility of a U.S. dollar decline, you might wish to reduce your exposure to U.S. stocks and other U.S. dollar assets. There are no bargains in the market for foreign-currency hedges.

We don’t recommend the iShares Core S&P 500 Hedged ETF.

Inner Circle recommendation: SELL