Horizons ETFs believes that investors should pay as little as possible for passive market returns. That’s the idea behind our family of Total Return Index ETFs (TRI ETFs), which are low-cost index replicating ETFs that use an innovative Investment structure know as a Total Return Swap (TRS) to deliver index returns in a cost effective and tax-efficient manner.

None of our TRI ETFs are expected to make any taxable distributions, which means they can offer greater tax efficiency than an ETF that physically buys and sell the securities that constitute the index it is tracking. All of our TRI ETFs track the total return version of their respective indices. This means that 100% of the index constituents’ distributions (dividends and interest income) are automatically reflected in the Net Asset Value (“NAV”) of the ETF when they are paid.

It’s similar to a dividend reinvestment plan, also known as a DRIP, in which the ETFs distributions are automatically reinvested in additional units of the ETF. However it differs in that there are no taxable distributions and the value is reflected in a higher NAV per unit rather than more ETF units.

For investors, the benefits of being invested in this type of ETF are the immediate compounding of total returns and the potential for substantial tax savings, since a tax liability only occurs when the ETF is sold at a capital gain.

Why are these ETFs not taxed upon receiving distributions?

The reason that TRI ETFs do not have to make taxable distributions is because the ETF does not receive distributions of dividend or interest income from the underlying securities. Rather, when using a TRS, the value of the distributions from the underlying index constituents to investors is reflected in the marked-to-market value of the swap, and consequently is reflected as an increase in the NAV per unit of the ETF.

Does this mean there is counterparty risk?

Yes. By using a TRS structure, our ETFs can take on some degree of counterparty risk. However, there are regulatory restrictions which govern who is eligible to be a counterparty and how much counterparty exposure is allowed in the ETF. The counterparty risk of an ETF is limited to the marked-to-market gains of the swap, and cannot exceed 10% of the NAV of the ETF, per counterparty, in accordance with National Instrument 81-102 (“NI 81-102”). Horizons ETFs manages the operations of the TRI ETFs to ensure that they comply with this limit.

Also in accordance with NI 81-102, the counterparty to any underlying over-the-counter (“OTC”) derivative (including a TRS) must maintain the following minimum credit rating: A (DBRS), A (Fitch), A2 (Moody’s), A (Standard & Poor’s). Only a few chartered banks in Canada meet this credit rating test.

In simple terms, a TRI ETF is only exposed to counterparty risk if the ETF is in a marked-to-market gain position and a maximum counterparty risk of 10% of the NAV per counterparty is allowed. There is no counterparty risk if the ETF is in a marked-to-market loss position. Each month, we post the counterparty risk level for each of our TRI ETFs on their associated webpage. One of the efficiencies of our ETF operations process is that, generally, our TRI ETFs are managed with the objective of maintaining a net marked-to-market loss position, meaning there is usually little to no counterparty risk for the ETF unitholder.

How often could the TRI ETFs exceed the 10% threshold?

It would be rare for the counterparty risk of a TRI ETF to approach or exceed 10% of the NAV per counterparty. Much of this has to do with the mechanics of how the swap operations are managed through the unit creation and redemption process.


One investor invests $100 into a TRS ETF and is the sole end-unitholder in the ETF. In this example, $100 is invested and held as cash collateral for the TRS in a custodial account. The counterparty of the swap is, therefore, obligated to increase the swap exposure to the underlying index by $100 to match the unitholder’s investment. On day 1 of this investment, the counterparty risk is zero.

Day 1: $100 investment - $100 in the swap = $0 or 0% ($0/$100) marked-to-market value of the swap in the ETF.

On Day 5. Let’s assume there is an exceptionally good week of market performance and the underlying index is up 10%. All else being equal, the counterparty now owes $10 to meet its obligation to deliver the returns of the index. The swap has a marked-to-market value of $10 + $100 of collateral (original investment), so the ETF’s NAV is $110. The counterparty exposure = $10 or 9.1% ($10/$110) of the NAV of the ETF.

The marked-to-market value of the swap would have to rise $11.20 to exceed the 10% counterparty threshold. This example only holds true if there is no redemption or subscription activity.

Now, let’s say another investor is enticed by the performance of the ETF and buys $100 of ETF units the next day, and the performance remains unchanged.

Day 6: $200 investment - $210 in the swap = 10$ or 4.8% (10$/210$) marked-to-market value of the swap in the ETF.

You can now see that the ETF has had its counterparty risk reduced almost in half with the increase in subscription activity. This happens on a daily basis in real life, where subscriptions into the ETF will tend to reduce the counterparty risk of the ETF.

Will redemptions increase counterparty risk?

Redemptions are actually beneficial to the management of the counterparty risk of the ETF. This is because Horizons ETFs can opt to pre-settle portions of any gains from the swap and assign that realized income to the redeeming unitholders of the ETF, which are almost always the Market Makers of the ETF*. Generally, Market Makers purchase or redeem units depending on their other trading activity in the units through the stock exchange.

When unitholders sell their ETF units through a stock exchange (the secondary market), this is not redemption; a redemption only occurs when Market Makers (or unitholders) redeem units directly with the Manger. Horizons ETFs will allocate income realized from redemptions, if any, to the Market Makers (i.e. income from the partial pre-settlement of the swap). This operation is disclosed in the Prospectus under the distribution policy and income tax consideration sections.

Why are TRI ETFs not re-characterizing taxes?

The pre-settlement of the swap during the redemption process may result in a taxable gain that is treated as regular income. However, through the process described above, any tax liability is allocated to, and borne by, the redeeming Market Maker of the ETF. Horizons ETFs has been consistently managing the operations of its TRI ETFs for over five years now and has yet to pay any income distributions to unitholders.

This unique swap management process accomplishes two goals: it keeps counterparty risk low or negative and it also allows for the effective management of the tax liabilities of the ETF, resulting in its current level of tax efficiency for unitholders.

*Unitholders can redeem their units directly with Horizons ETFs, provided that they do not redeem their units directly with the ETF; the unit holder is not expected to receive any distributions of income. Unitholders are encouraged to sell their unit through the facilities of a stock exchange.

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Horizons ETFs is a Member of Mirae Asset Global Investments. Commissions, trailing commissions, management fees and expenses all may be associated with an investment in exchange traded products managed by Horizons ETFs Management (Canada) Inc. (the "Horizons Exchange Traded Products"). The Horizons Exchange Traded Products are not guaranteed, their values change frequently and past performance may not be repeated. The prospectus contains important detailed information about the Horizons Exchange Traded Products. Please read the relevant prospectus before investing.

The Horizons Exchange Traded Products consist of the Horizons Index ETFs ("Index ETFs"), 2x Daily Bull and -2x Daily Bear ETFs ("2x Daily ETFs"), Inverse ETFs ("Inverse ETFs"), VIX ETFs (defined below) and active ETFs. The 2x Daily ETFs and certain other Horizons Exchange Traded Products use leveraged investment techniques that can magnify gains and losses and may result in greater volatility of returns. These Horizons Exchange Traded Products are subject to leverage risk and may be subject to aggressive investment risk and price volatility risk, which, where applicable, are described in their respective prospectuses. Each 2x Daily ETF seeks a return, before fees and expenses, that is either 200% or -200% of the performance of a specified underlying index, commodity or benchmark (the "Target") for a single day. Each Index ETF or Inverse ETF seeks a return that is 100% or -100%, respectively, of the performance of a Target. Due to the compounding of daily returns, a 2x Daily ETF's or Inverse ETF's returns over periods other than one day will likely differ in amount and possibly direction from the performance of their respective Target(s) for the same period. The Horizons Exchange Traded Products whose Target is the S&P 500 VIX Short-Term Futures Index™ (the "VIX ETFs"), one of which is a 2x Daily ETF and one of which is an Index ETF, as described in their prospectus, are speculative investment tools that are not conventional investments. The VIX ETFs' Target is highly volatile. As a result, the VIX ETFs are not generally viewed as stand-alone long-term investments. Historically, the VIX ETFs' Target has tended to revert to a historical mean. As a result, the performance of the VIX ETFs' Target is expected to be negative over the longer term and neither the VIX ETFs nor their Target are expected to have positive long term performance. Investors should monitor their holdings, as frequently as daily, to ensure that they remain consistent with their investment strategies.

*The indicated rates of return are the historical annual compounded total returns including changes in per unit value and reinvestment of all dividends or distributions and do not take into account sales, redemption, distribution or optional charges or income taxes payable by any securityholder that would have reduced returns. The rates of return shown in the table are not intended to reflect future values of the ETF or returns on investment in the ETF. Only the returns for periods of one year or greater are annualized returns.