Putting Gold To Work  

Gold is a polarizing asset class. Similar to champions of certain types of nutrition and health supplements, ardent followers of gold can have an unwavering belief that gold should be a constant and large portion of a person’s portfolio. On the other hand, there are those who view gold as a fetishized commodity that offers little value for an investment portfolio.

As with most things, the truth probably lies somewhere in between. Historically, there seems to be some modest value to owning gold — particularly as a deflationary hedge or defensive asset class — but one of the single biggest challenges for most investors in owning gold is that it doesn’t pay out an income stream, which puts it at odds with its perceived value as an asset class that thrives during low interest rates and market volatility.

Here’s a chart showing the price of gold futures vs. U.S. 10-year real yields over the last 20 years. It’s a near perfect inverse correlation. As real interest rates decline, the price of gold rises; conversely, as real interest rates rise, gold tends to stall, if not decline at some points.

chart1.png

Source: Bloomberg, from June 30, 2000 – June 30, 2020.

There is some debate about the merits of gold as an inflationary hedge; for example, is it any better at providing an inflationary hedge than other commodities priced in U.S. dollars, or even equities for that matter? An interesting study from 2012 by the National Bureau of Economic Research, authored by Duke University professor Campbell Harvey and Claude Erb, largely debunked the idea of holding gold as an inflation hedge, while highlighting that it does hold up as store of value – that is, it retains its value during rising inflation, but other assets might actually generate strong positive returns during inflation.

Let’s think of this from a retail investment portfolio perspective and take market timing out of the equation. Since gold clearly has bull and bear markets where investors can make speculative profits, the value for most investors in gold is probably as a defensive asset class; that is, an asset class that holds its value or increases in value during periods of market impairment.

Let’s think of the conditions that arise during a broad capital markets selloff. We have historically observed high volatility, declining values in many asset classes (correlations moving to 1) and declining interest rates. It’s this last feature, declining rates, where gold provides value. As highlighted above, gold historically rallies on declining rates, but this provides a conundrum for an increasingly aging demographic of investors as to where to get their income in such an environment.

Increasingly, investors have a need for income. Central bank rates are close to zero, or negative in some circumstances.

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Source: Bloomberg, as at June 30, 2020.

Holding gold can provide some capital cushion for investors but it doesn’t solve the income need. This is where several ETFs offered by Horizons ETFs, including the Horizons Gold Yield ETF (HGY) and the Horizons Enhanced Gold Producers ETF (HEP), can offer value for investors.

These two ETFs provide exposure to gold and gold equities, while providing a monthly income stream by writing covered calls. These strategies effectively allow investors to take a long position in gold or gold equities, while having a portion of their total net returns delivered back to them in a tax efficient manner.

The value in this for investors is that they can have meaningful exposure to gold, take advantage of its benefits during a period of declining interest rates, but also generate a tax-efficient income stream during the very period where they likely need more income.

Horizons Gold Yield ETF (HGY)

HGY seeks to provide unitholders with:

1. Exposure to the price of gold bullion hedged to the Canadian dollar, less the ETF’s fees and expenses;
2. Tax-efficient monthly distributions, which can mitigate downside risk, and exposure to a covered call option strategy; and
3. The portfolio management team writes on approximately, but not more than, 33% of the securities of the gold portfolio. The level of covered call option writing to which Horizons HGY is exposed may vary based on market volatility and other factors. Generally, investors get two-thirds of the upside exposure to the price of gold, and a potentially attractive monthly income stream generated by at-the-money options written on approximately 33% of the portfolio’s holdings.

HGY gives investors exposure to physical gold, but effectively returns 33% of the return trajectory as income, in a tax efficient manner. Historically a considerable amount of this return has been characterized as Return of Capital (ROC) rather than capital gains. In circumstances where the ETF is in a capital loss position for the calendar year, but has paid out distributions, there is a greater likelihood of the distributions being characterized as ROC.

Horizons Enhanced Gold Producers ETF (HEP)

The investment objective of HEP is to provide unitholders with:

1. Exposure to the performance of an equal weighted portfolio of North American-listed gold mining and exploration companies; and
2. Monthly distributions of dividend and call option income.

HEP invests primarily in a portfolio of equity and equity-related securities of North American-listed companies that are primarily exposed to gold mining and exploration and that, as at the constituent reset date, are among the largest and most liquid issuers in their sector. It currently holds 15 stocks that are equally weighted, as at June 30, 2020.

HEP will generally write covered call options on 100% of the portfolio securities. The level of covered call option writing may vary based on market volatility and other factors. The level of writing that the portfolio management team utilizes, often referred to as the delta coverage of the portfolio, will vary, so that while 100% of the portfolio is being written on, the amount of options coverage is typically less than 100%.

Again, the goal here is provide exposure to gold equities, where investors get the majority of the upside performance of the equity holdings while receiving monthly income. The big difference between HEP and HGY, aside from the fact that HGY invests in physical gold and HEP invests in equities, is that HEP writes covered calls out-of-the-money, with strike prices that are set dynamically based on the stock’s volatility. The higher the volatility, the more out-of-the-money the option price is, which gives the stock more upside runway on its pricing, and generally provides a steady amount of option premium.

Compared to physical gold, equities have the added advantage of providing operational leverage. Many of the producers have engaged in aggressive cost-cutting and balance sheet improvements over the last decade and can see substantial revenue advantages when the price of gold rises. This can be observed with the strong correlation to rising gold prices during the last four years in the chart below.

Gold Equities vs. Gold Prices

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Source: Bloomberg, as at June 30, 2020.

In both cases, the yields generated by these ETFs have fluctuated with market conditions and volatility, but have remained attractive for the near-decade that Horizons ETFs has been offering them.

Calendar Yields

  Jun-20 2019 2018 2017 2016 2015 2014 2013 2012 2011
Horizons Gold Yield
ETF (HGY)
4.41% 4.20% 4.67% 4.63% 5.39% 6.16% 6.32% 7.80% 9.01% 8.01%
Horizons Enhanced
Income Gold Producers
ETF (HEP)
5.05% 4.58% 5.27% 7.09% 9.21% 11.61% 11.31% 18.44% 14.54% 16.91%
 

Source: Bloomberg as at June 30, 2020.

The ETFs do not have fixed distributions but pay distributions monthly. Distributions are generally based on the net premiums resulting from the writing of covered calls, any dividend income received, less expenses payable by the ETF. The amount of monthly cash distributions fluctuates from month to month and there can be no assurance that an ETF will make any distributions in any particular month. Monthly distributions will be paid in cash, unless the investor has enrolled in the ETF’s dividend reinvestment plan.

Even in today’s low-rate environment, HEP and HGY are still yielding in excess of 4%, while also benefitting from the strong rise in gold prices (up 26.35% for the one year period ending June 30, 2020). It’s an effective way to truly put gold to work for a portfolio that needs a consistent income stream!

  1
Month
3
Months
6
Months
YTD 1
Year
3
Years
5
Years
Since
Inception
Inception
Date
Horizons Enhanced
Income Gold Producers
ETF (HEP)
3.01% 45.98% 20.86% 20.86% 42.29% 20.45% 17.20% -1.41% 11/04/2011
Horizons Gold Yield
ETF (HGY)
2.43% 12.37% 14.53% 14.53% 21.64% 8.76% 5.07% -0.18% 17/12/2010
 

Source: Bloomberg as at June 30, 2020.

The indicated rates of return are the historical annual compounded total returns, including changes in unit value and reinvestment of all 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. ETFs are not guaranteed, their values change frequently, and past performance may not be repeated.

Certain statements may constitute a forward-looking statement, including those identified by the expression “expect” and similar expressions (including grammatical variations thereof ). The forward-looking statements are not historical facts but reflect the author’s current expectations regarding future results or events. These forward-looking statements are subject to a number of risks and uncertainties that could cause actual results or events to differ materially from current expectations. These and other factors should be considered carefully and readers should not place undue reliance on such forward looking statements. These forward-looking statements are made as of the date hereof and the authors do not undertake to update any forward-looking statement that is contained herein, whether as a result of new information, future events or otherwise, unless required by applicable law.

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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 (the “BetaPro Products”). The BetaPro Products are alternative mutual funds within the meaning of National Instrument 81-102 Investment Funds, and are permitted to use strategies generally prohibited by conventional mutual funds: the ability to invest more than 10% of their net asset value in securities of a single issuer, to employ leverage, and engage in short selling to a greater extent than is permitted in conventional mutual funds. While these strategies will only be used in accordance with the investment objectives and strategies of the BetaPro Products, during certain market conditions they may accelerate the risk that an investment in shares of a BetaPro Product decreases in value. The BetaPro Products consist of our Daily Bull and Daily Bear ETFs (“Leveraged and Inverse Leveraged ETFs”), Inverse ETFs (“Inverse ETFs”) and our BetaPro S&P 500 VIX Short-Term Futures™ ETF (the “VIX ETF”). Included in the Leveraged and Inverse Leveraged ETFs and the Inverse ETFs are the BetaPro Marijuana Companies 2x Daily Bull ETF (“HMJU”) and BetaPro Marijuana Companies Inverse ETF (“HMJI”), which track the North American MOC Marijuana Index (NTR) and North American MOC Marijuana Index (TR), respectively. The Leveraged and Inverse Leveraged 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, among other risks, which are described in their respective prospectuses. Each Leveraged and Inverse Leveraged ETF seeks a return, before fees and expenses, that is either up to, or equal to, either 200% or –200% of the performance of a specified underlying index, commodity futures index or benchmark (the “Target”) for a single day. Each Inverse ETF seeks a return that is –100% of the performance of its Target. Due to the compounding of daily returns a Leveraged and Inverse Leveraged ETF’s or Inverse ETF’s returns over periods other than one day will likely differ in amount and, particularly in the case of the Leveraged and Inverse Leveraged ETFs, possibly direction from the performance of their respective Target(s) for the same period. For certain Leveraged and Inverse Leveraged ETFs that seek up to 200% or up to or -200% leveraged exposure, the Manager anticipates, under normal market conditions, managing the leverage ratio as close to two times (200%) as practicable however, the Manager may, at its sole discretion, change the leverage ratio based on its assessment of the current market conditions and negotiations with the respective ETF’s counterparties at that time. Hedging costs charged to BetaPro Products reduce the value of the forward price payable to that ETF. Due to the high cost of borrowing the securities of marijuana companies in particular, the hedging costs charged to HMJI are expected to be material and are expected to materially reduce the returns of HMJI to unitholders and materially impair the ability of HMJI to meet its investment objectives. Currently, the manager expects the hedging costs to be charged to HMJI and borne by unitholders will be between 10.00% and 45.00% per annum of the aggregate notional exposure of HMJI’s forward documents. The hedging costs may increase above this range. The manager publishes on its website, the updated monthly fixed hedging cost for HMJI for the upcoming month as negotiated with the counterparty to the forward documents, based on the then current market conditions. The VIX ETF, which is a 1x 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 intended as a 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 ETF’s 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 in BetaPro Products and their performance at least as frequently as daily to ensure such investment(s) remain consistent with their investment strategies.

Horizons Total Return Index ETFs (“Horizons TRI ETFs”) are generally index-tracking ETFs that use an innovative investment structure known as a Total Return Swap to deliver index returns in a low-cost and tax-efficient manner. Unlike a physical replication ETF that typically purchases the securities found in the relevant index in the same proportions as the index, most Horizons TRI ETFs use a synthetic structure that never buys the securities of an index directly. Instead, the ETF receives the total return of the index through entering into a Total Return Swap agreement with one or more counterparties, typically large financial institutions, which will provide the ETF with the total return of the index in exchange for the interest earned on the cash held by the ETF. Any distributions which are paid by the index constituents are reflected automatically in the net asset value (NAV) of the ETF. As a result, the Horizons TRI ETF receives the total return of the index (before fees), which is reflected in the ETF’s share price, and investors are not expected to receive any taxable distributions. Certain Horizons TRI ETFs (Horizons Nasdaq-100 ® Index ETF and Horizons US Large Cap Index ETF) use physical replication instead of a total return swap. The Horizons Cash Maximizer ETF and Horizons USD Cash Maximizer ETF use cash accounts and do not track an index but rather a compounding rate of interest paid on the cash deposits that can change over time.

*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.