Blogs & Comment

Roundup on BetaPro’s new ETF (HXT)

A new exchange-traded fund (ETF) is creating quite a stir. The Horizons BetaPro S&P/TSX 60 Index Fund ( HXT) has a rock-bottom management expense ratio (MER) of 0.07%, less than half the MERs charged by the equivalent iShares and BMO ETFs.
Q: How is such a low MER possible?
A: The HXT doesnt buy and hold stocks like the other ETFs. It has a 5-year swap agreement with National Bank Financial. Under that agreement, the bank pays HXT unitholders the total return earned by the S&P/TSX 60 Index. The swap eliminates the expense of trading stocks and rebalancing.
In exchange for the return provided by the swap, the ETF pays the bank interest on the cash received from the initial sale of units (and pledges the cash to secure its obligation to pay interest). For the swap to function smoothly, the bank needs to hedge its exposure to stock-market risk.
Q: OK, so there are some hidden fees somewhere?
A: To quote the prospectus: The Trust Declaration requires that the Manager pay all the expenses of the ETF other than the Management Fee and any Sales Taxes on the Management Fee. As a result the ETF does not have any other expenses.
Q: What about National Bank Financial or some other counterparty going out of business and stopping payment of the return under the swap agreement?
A: Such defaults are rare, particularly for Canadian banks. Moreover, as the prospectus says: the exposure of the ETF to any one counterparty will generally not exceed 10% of the net asset value of the ETF and will at all times be in accordance with NI 81-102.
Q: Are there other catches?
A: The dividend portion of the total return is not distributed to unitholders but automatically “reinvested.” This may not appeal to income investors or those living off dividends. On the other hand, it could appeal to investors still in the capital accumulation phase. They wont need to bear the administrative work and costs of reinvesting dividends. In addition, the HXT offers greater tax efficiency in taxable accounts; foreign investors would not face withholding taxes either.
Q: Will the swap agreement accurately track the S&P/TSX 60 Index?
A: It should track the index with less tracking error than the iShares and BMO offerings. The return is not on a best-efforts basis like iShares and BMO, but based a binding commitment from the counterparty to pay the precise total return on the index.
Q: What do others think?
There is coverage and commentary from Jonathan Chevreau, Rudy Luukko, Rob Carrick and Canadian Capitalist (Part I & Part II). The reception seemed on balance favourable, but with some caveats. Some highlights:
From Chevreau:
Were pretty certain BetaPro is using this as a loss leader, said Oliver McMahon, head of product management for iShares Canada, and we know what happens to loss leaders in the long term [the licensing fee alone accounts for two to five basis points].
At BMO ETFs, chief investment officer Kevin Gopaul questioned whether retail investors will benefit from BetaPro ETFs tax efficiency in the same way as institutional investors. Gains in derivatives are treated as income, not capital gains. Swaps have a quarterly reset. Im not 100% convinced its tax efficient yet.
From Luukko:
Should investors be concerned [about counterparty risk]? Not really. The fund’s cash holdings, its simple and clearly disclosed strategy, the lack of leverage, the diversification by and the high creditworthiness of counterparties such as National Bank Financial all suggest that the counterparty risk associated with this fund is very slight.
From Carrick:
This is very much a new marketplace, so providers will be seeking market share,” said Rajiv Silgardo, head of BMO’s ETF operation. Mr. Silgardo sees limits, though. “Unless you have a really thought-through business strategy, some of these pricing schemes will probably end up in tears, so to speak. They may not be sustainable.”
Canadian Capitalist:
In my opinion, the use of derivatives makes HXT an unsuitable core Canadian equity holding.