I recently bought Broadcom Inc. (AVGO-Q), IBM (IBM-N) and Meta (META-Q) on the Toronto Stock Exchange and paid one-fifth to one-20th of the price on a U.S. exchange. How was this possible? If these companies pay a dividend, do I receive one, and in what currency? Are there any risks to acquiring these types of shares?
It’s possible because, strictly speaking, you haven’t bought shares in these companies directly. You’ve bought Canadian depositary receipts.
CDRs are Canadian-dollar instruments issued by CIBC Capital Markets and BMO Global Asset Management that let investors trade global companies on Canadian exchanges. You don’t pay the full U.S. sticker price for a CDR because they are priced using something called a CDR ratio, which is a measure of how much exposure a single CDR gives you to the underlying shares.
Your CIBC-issued Meta CDR currently has a CDR ratio of around 0.037, meaning that one CDR is equivalent to about 0.037 Nasdaq-traded Meta shares. Buy 27 Meta CDRs and you’ve given yourself exposure to about one Nasdaq-traded Meta share.
This can be a useful way to gain fractional exposure to pricey foreign stocks – Meta shares were changing hands at about US$750 on the Nasdaq Stock Market on Friday – especially if you’re using a platform that doesn’t allow you to trade fractional shares.
The CDR ratio fluctuates to account for changes in the exchange rate between the Canadian dollar and the currency of the underlying shares. For a cost of about 0.6 per cent per year, embedded in the CDR’s price, this provides a hedge against currency moves. The idea is that your CDR’s performance should reflect the performance of the underlying company’s shares, not of the company’s home currency.
If the underlying shares are eligible for voting rights, so are you (in proportion to the CDR ratio), and any dividends are issued, again proportionately, in Canadian dollars.
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Be aware, though, that as with ordinary foreign shares these dividends are not eligible for the dividend tax credit, and are usually subject to foreign withholding tax. Sonya Dolguina, a tax adviser at Raymond James in Vancouver, said that for the 70 per cent of CDRs that are based on U.S. shares, Canadians can at least claim exemptions from U.S. withholding tax in a retirement account – an RRSP, RRIF, LIRA or LIF.
You’ll also want to be careful with a TFSA, FHSA, RESP or RDSP. These accounts may be less attractive for dividend-paying CDRs because foreign withholding tax generally can’t be recovered through a tax credit.
While we’re on the topic of taxes, CIBC spokesman Andrew McGrath confirmed that the Canada Revenue Agency counts CDRs as “specified foreign property,” as is usual for foreign company shares. If the cost of your specified foreign property exceeds $100,000 at any point in the year, you’ll need to say so on a T1135 Foreign Income Verification Statement form (shares and CDRs held in a registered account are exempt). The penalties for not complying are stiff.
The risks associated with CDRs are, for the most part, the risks associated with buying shares in any company: If the stock price goes to zero, so does the CDR. If a company goes bankrupt, you are at the back of the line with the other equity holders when sorting out claims.
Some CDRs have very low trading volumes, but BMO and CIBC say liquidity is more closely tied to trading activity in the underlying shares. At the same time, the bid-ask spread, the difference between prices being offered by buyers and requested by sellers, may be significantly wider for even an actively traded CDR than that of the underlying shares, potentially raising your trading costs.
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As I write this, the bid-ask spread of the CIBC Meta CDR is 0.07 per cent, against 0.01 per cent for Meta shares.
You should also pay close attention to your calendar.
If you’re buying or selling a Meta CDR on a U.S. market holiday, you may encounter more volatile prices and even wider spreads. BMO and CIBC both suggest placing limit orders as a general rule, which allows you to set specific buy or sell prices. If you submit a market order, your brokerage will try to fill it as soon as possible, regardless of the current price.
Finally, you should be aware that currency hedging can work against you. An investor holding U.S. shares directly would see the Canadian dollar value of their U.S. investment rise if the loonie were to weaken against the greenback. By design, CDR holders wouldn’t see a similar boost.
CDRs can still make sense if you value the stability of a currency hedge, don’t want to bother with foreign currency accounts and can’t easily buy fractional shares. Personally, I would skip the additional costs and buy shares directly through a more flexible brokerage.
E-mail your questions to agalbraith@globeandmail.com. I’m not able to respond personally to e-mails but I choose certain questions to answer in my column.