Horizons ETFs believes that investors should pay as little as possible for market returns. A total return swap (TRS) is an innovative approach to delivering Canadian market returns in a cheaper and more tax-efficient manner.

A TRS is commonly used by large institutional investors. It is simply an agreement between investors and a large financial institution (the “counterparty”) whereby the investors exchange (or “swap”) their capital, which is held as cash in a custodial account, for the total return delivered by another asset such as a stock market index.

Key Benefits of a TRS for an ETF

• Lower Fees: The TRS structure reduces the trading expenses that are associated with traditional funds that replicate an index by purchasing all the individual underlying stocks of a portfolio
• Improved Tracking: Since the counterparty is obligated to deliver exact index returns, a TRS structure can greatly reduce the potential for tracking error
• Tax Efficient: The TRS used in the Horizons ETFs allows the value of dividends to be reflected directly in the net asset value (NAV) rather than paid out separately as a taxable distribution

How a TRS Works

The following example outlines how a $100 investment in the Horizons S&P/TSX 60TM Index ETF would be invested to gain exposure to its underlying index.

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A Low Risk* Structure

Canadian index ETFs that use a TRS structure do have counterparty risk that generally does not exist with a traditional physical replication fund, however this risk is managed to stay low.

• The counterparties on a the TRS are typically the largest financial institutions in Canada
• The posted collateral for the swap is cash and held on account with the ETF’s custodians
• Units of the ETF can be redeemed at any time with no impairment to the net asset value of the ETF

*Low Risk, in this instance, refers to the average level of Counterparty Risk, on a percentage basis, and the credit risk of the swap counterparties. It is not a reflection of the risk level of the individual ETFs that utilize Total Return Swaps to achieve their investment exposure. Each of those ETFs will have their own risk level classification, and may range anywhere from Low to High.

Counterparty Risk

Counterparty risk only exists if the ETF is in a positive mark-to-market position relative to the notional value of the TRS, and this positive marked-to-market value cannot, in accordance with National Instrument 81-102 governing Canadian mutual funds, exceed 10% of the ETF’s net asset value.

The likelihood of an ETF counterparty, which is a large Schedule 1 Bank, facing financial impairment during a rising Canadian stock market is in our view quite remote considering the prevalence of these institutions in the Canadian stock market.

The table below outlines market conditions in which counterparty risk, if any, would exist and the options available to the ETF to reduce the risk:

Marked-To-Market Value of ETF

<0% 0-5% 5-10% >10%
No counterparty risk.
The ETF owes the
counterparty.
Counterparty
risk exists.
Counterparty
risk exists.
The ETF can bring on additional
TRS counterparties or execute
pre-settlement of a portion of the
TRS to ensure the counterparty risk
falls back in line with 81-102 rules,
and is reduced back below 10%.
 

The counterparty to the TRS is required to maintain a minimum credit rating equivalent to the following for each applicable rating service: DBRS rating of A, Fitch rating of A, Moody’s rating of A2, and/or an S&P rating of A.

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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 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.