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The Costs of Currency Hedging: Taxes

Posted on May 11, 2008

In an earlier post, we discussed how investing in funds that hedge the exposure to foreign currencies entails a significant cost in terms of a large tracking error. There is a further cost involved in holding these funds: taxes. It is no surprise that currency-neutral funds could generate large taxable distributions - by their very nature, currency contracts are short-term instruments that trigger a taxable event at the time of settlement.For instance, 11.9% and 37.0% of the returns of the iShares S&P 500 Index Fund (IVV) were in the form of dividends and hence taxable in 2006 and 2007 respect...

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