Larry MacDonald wondered how I calculated the numbers reported in the post on the historical tracking error of the iShares CDN S&P 500 Index Fund (XSP) as the tracking error chart on the iShares website reports a much smaller error. For 2006, 2007 and 2008, the tracking error reported by the iShares website is 0.34%, 0.56% and 1.31% respectively. Recall that the tracking error reported in the earlier post was wildly different for the same years: 1.73%, 2.30% and 3.5%.
While there is a small difference in the total return calculation for XSP, the bulk of the difference can be attributed to the annual return calculations for the benchmark. I used the total return of the iShares S&P 500 Index Fund (IVV) as the benchmark and my calculations agree with the numbers reported by the ETFConnect website. As the iShares website notes that XSP tracks the “the S&P 500 Hedged to Canadian Dollars Index”, it is entirely possible that the difference in tracking errors can be attributed to using different benchmarks.
But for investors, all this discussion of benchmarks is academic in deciding whether they want to hedge their currency exposure or not because the bottom line is simple: what is the difference in performance between IVV in Canadian dollars and XSP? On this score, the short history of XSP isn’t very encouraging. Over the 3 years ending 31st December 2008, XSP lost 29.68% compared with a loss of 22.75% for IVV. During the same time period, the Canadian dollar depreciated from 86 cents to 82 cents, meaning that an unhedged exposure to IVV would have lost even less. Even if the dollar had instead appreciated to 92 cents over the same time period, the returns in Canadian dollars for IVV and XSP would have been the same (ignoring currency conversion charges). Given the rather significant costs involved in hedging, it seems that long-term investors will almost certainly be better off with a direct holding in foreign stocks and taking their chances with foreign currency fluctuations.