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 ETFs (TRI ETFs), which are low-cost index replicating ETFs that use an innovative investment structure, known as a Total Return Swap (TRS) delivering index returns in a cost effective and tax-efficient manner.

None of our TRI ETFs are expected to make any taxable distributions, which means it can offer a greater amount of tax efficiency than an ETF that physically buys and sells the securities that it holds.

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 received.

It’s similar to a dividend reinvestment plan, also known as a DRIP, in which distributions get automatically reinvested, but differs in that they are not a taxable distribution, but are rather reflected in the account’s total value.

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 total return swap, the value of the distributions from the underlying index to investors is reflected in the marked-to-market value of the swap, and consequently is reflected as an increase in the NAV of the ETF.

Does this mean there is counterparty risk?

Yes. By using a TRS structure, our ETFs can take on some amount of counterparty risk compared to a physically replicated ETF. In our view however, this risk is quite small as there is legislation in force to limit who is eligilbe to be a counterparty and how much counterparty exposure is allowed in the ETF.

The most important aspect an investor needs to understand about counterparty risk is that the marked-to-market gains of the swap 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 always 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, this means that a TRI ETFs can only be exposed to counterparty risk if the ETF is in a marked-to-market gain scenario and the maximum counterparty risk 10% of the NAV per counterparty. There is no counterparty risk if the ETF is in a marked-to-market loss scenario. We post the counterparty risk (marked-to-market gains or losses) for each of our TRI ETFs on their associated webpage. One of the efficiencies of our ETF operations process is that that generally our TRI ETFs are managed so that they are in a marked-to-market loss scenario, meaning there is usually no current counterparty risk for the ETF unitholder.

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

It would be rare that a TRI ETF is in a situation where the counterparty risk of the ETF approaches 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-tomarket 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.

Day 6: $200 investment - $210 in the swap = 10$ or 4.8% (10$/210$) is the 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, the Market Makers who purchase these units, depending on their other trading activity in the units, can decide to subscribe or redeem the units.

When unitholders sell their ETF units through a stock exchange (the secondary market), this is not redemption; a redemption only occurs when Market Makers redeem those units they have purchased in the secondary market. Horizons ETFs will allocate any income generated, if any, from redemptions 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 results in a taxable gain that is treated as income. However, the tax liability from their inception is borne by the Market Makers of the ETFs. Horizons ETFs has been consistently managing the operations of the TRI ETFs for over four years now and has yet to pay any income distributions to its unitholders during this period.

This unique swap management process does two things: it keeps counterparty risk negative or quite low and it also allows for the effective management of the tax liabilities of the ETF, resulting in its current tax efficient structure for unitholders.

*Unitholders can redeem their units directly with Horizons ETFs, but it is important to note that provides unitholders does 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, 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 include our BetaPro Products which consist of our 2x Daily Bull and 2x Daily Bear ETFs ("2x Daily ETFs"), Inverse ETFs ("Inverse ETFs") and our VIX ETF (defined below). The 2x Daily ETFs and certain other BetaPro Products use leveraged investment techniques that can magnify gains and losses and may result in greater volatility of returns. These BetaPro 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 Inverse ETF seeks a return that is -100% 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, for the 2x Daily ETFs, possibly direction from the performance of their respective Target(s) for the same period. The BetaPro Product whose Target is the S&P 500 VIX Short-Term Futures Index™ (the "VIX ETF"), which is a (1x) VIX ETF, as described in the prospectus, is a speculative investment tool that is not a conventional investment. The VIX ETF’s Target is highly volatile. As a result, the VIX ETF is not generally viewed as stand-alone long-term investment. Historically, the VIX ETF’s 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 ETF nor its Target is 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.