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HORIZONS ETFs: ADVANCED ETF STRATEGIES. ETF FORUM – Montreal Jaime Purvis, Executive Vice-President Horizons Exchange Traded Funds October 2011. Benefits of ETF Structure. Low-Cost Tax Efficient Intra-Day Liquidity Precise Asset Class Exposure

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HORIZONS ETFs:ADVANCED ETF STRATEGIES

ETF FORUM – Montreal

Jaime Purvis, Executive Vice-PresidentHorizons Exchange Traded FundsOctober 2011

benefits of etf structure
Benefits of ETF Structure
  • Low-Cost
  • Tax Efficient
  • Intra-Day Liquidity
  • Precise Asset Class Exposure
  • ETF is an agnostic structure – can be used to implement a wide variety of investment strategies

Disadvantages

  • Cannot subscribe at end of day net asset value per share (NAVPS)
  • Subject to trading commissions
popular etf strategies
POPULAR ETF STRATEGIES

Core Holdings (Switch Opportunities)

  • Complement your longer-term core-equity holdings
  • Switch into ETFs that offer a competitive advantage, such as better performance and lower tax consequences

Cash Equitization

  • Instant market exposure or part of tax loss harvesting strategy
  • Quickly & efficiently utilize cash accumulated during equity rotation or asset allocation rebalancing

Risk Mitigation / Volatility Control

  • Manage the risk of over concentration to sectors within the TSX 60
  • Hedge existing long positions to dampen volatility without the tax consequences associated with selling securities
cash equitization a dominant institutional etf strategy
Cash Equitization – A Dominant Institutional ETF Strategy
  • Portfolio managers generally try to outperform the market but being in the market is better than not at all
  • ETFs can be used to quickly deploy cash into sectors while managers conduct due diligence on individual securities
  • To gain long-term exposure to specific asset classes: foreign, small cap, sector etc
  • More than half of U.S. asset managers use passively managed ETFs in an actively managed portfolio
  • Three quarters of U.S. asset managers (75%) use ETFs for gaining rapid exposure to an asset class (i.e., cash equitization) and 63% of institutional fund respondents use ETFs during the transition management process. (source: Greenwich & Associates)

Putting Cash To Work

rim a case study
RIM: A Case Study

XIT: -7.12%

RIM is still 22% of S&P/TSX Capped Information Technology Index

RIM: -57.31%

Source: Bloomberg from September 29, 2010 to September 29, 2011

tax loss harvesting
Tax Loss Harvesting

For Illustrative Purposes Only

  • Bullish on RIM long term? Sell RIM, harvest capital losses and buy and hold XIT (S&P/TSX Capped Information Technology Index ETF) for 30 days
  • Bullish on S&P/TSX 60? Sell XIU, harvest capital losses and buy HXT or vice versa
  • Bullish on RBC? Sell RBC, harvest capital losses and buy XFN (S&P/TSX Capped Financials Index ETF)
  • Bullish on Barrick? Sell it, harvest losses and buy XGD (S&P/TSX Global Gold Index ETF )
  • ETFs can be used to harvest capital losses, sell a security and buy a correlated index. Or even sell an index, and buy the same index through another provider. Capital losses can be used against capital gains in the previous three years or carried forward indefinitely
advanced investing strategies
ADVANCED INVESTING STRATEGIES
  • Alpha Generation
    • Directional Plays or Pair Trading, Alpha Isolation
  • Beta Efficiency
    • Index exposure with only 50% of capital requirement
    • Enables a portable alpha strategy
  • Straddles
    • Buy the pair of Long and Short ETFs in anticipation of a large, but unknown, directional move up or down
etfs 3 0 what is a total return swap
ETFs 3.0: What Is A Total Return Swap?
  • A TRS is an agreement between two parties where one party makes a payment to the other, based on the return of a particular asset, in exchange for a payment from the other party based on the return of a different asset.
  • Obligation rests on the swap provider to deliver upon the agreed investment objective or returns. There is counterparty risk associated with swaps – the swap provider must have the ability to deliver the returns - but investors end up with low cost, and usually precise delivery of returns.
  • Frequently used by large institutional investors, such as pension plans and large endowments.
  • Easy to use on large-cap equity indices where liquidity of the underlying stocks is abundant.
  • Swap provider makes money on the swap fee, if any, and potentially can find arbitrage opportunities to make additional returns with the investor money.
etfs 3 0 total return swap
ETFs 3.0: Total Return Swap

Equity Index

ETF

Obligated to deliver precise index returns

Counterparty (Financial Institution)

Hedges exposure

swap based etfs in europe
SWAP BASED ETFs IN EUROPE
  • According to statistics from BlackRock*, the number of swap-based ETFs available in Europe rose to 683 by the end of last year from 27 in 2005, outpacing the growth of physical replication ETFs, which increased from 138 to 385 over the same period.
  • Most prolific provider is Deutsche Bank’s db x-trackers. iShares has numerous swap-based ETFs as well.
  • Preference to use swap structure for indices that are difficult to replicate or track. Swap-backed ETFs also offer the ability to access indices that physically backed ETFs would find impossible to track – such as indices on certain emerging markets or commodities, for example.

.

  • With swap-backed products, the ETF provider in effect outsources this risk to an investment bank. The efficiencies, get passed to the end investor in the form of lower Total Expense Ratios.
  • UCITs regulation in Europe ensures the credit risk on swap-based ETFs remains very low.

*BlackRock ETF Landscape: Industry Review Feb, 2011

how they have been used
HOW THEY HAVE BEEN USED
  • Can be used on a variety of asset classes, from debt and equities to commodities and futures
  • Particularly ideal for delivering index returns
  • Some large pension plans get index returns through a Total Return Swap (TRS) with a major financial institution. A TRS can generally deliver the investor the exact return of the index, thereby eliminating tracking error less any costs, if applicable
  • In Europe, where traditional investment banks are also major ETF providers, swap-based index ETFs are commonplace
  • ETFs cannot deliver perfect correlation but can reduce it using a TRS structure
impact of a lower negative tracking error
IMPACT OF A LOWER NEGATIVE TRACKING ERROR

Difference of return over 10 years

* Compounded daily total return over 10 years.

credit risk on canadian swap etfs low
CREDIT RISK ON CANADIAN SWAP ETFS LOW
  • In the Horizons index ETFs that use a TRS only positive gains are subject to counterparty risk. No Counterparty risk associated with investor’s principle investment.
  • 100% of the principal investment is held in cash and/or equivalents.
  • Counterparty risk is limited to the mark-to-market value of the TRS, which in accordance with National Instrument 81-102, cannot generally exceed 10% of the net asset value (“NAV”) of the ETF.
  • The counterparty to an underlying OTC derivative (including a TRS) must maintain a minimum credit rating equivalent to the following for each applicable credit rating service: DBRS rating of A, Fitch rating of A, Moody’s rating of A2, and/or an S&P rating of A.
  • The initial counterparty risk of the ETF at the time of launch is zero as there is no mark-to-market value to the TRS.
how is a swap etf different than an etn
HOW IS A SWAP ETF DIFFERENT THAN AN ETN
  • ETNs have grown in popularity in the U.S. as a means to get precise tracking error delivery of hard to replicate asset classes, such as copper, volatility and longer-dated leverage returns.
  • Investors in Exchange Traded Notes assume 100% of the counterparty risk that the ETN provider will be able to deliver the returns of the referenced asset class, index or security.
tax advantages
TAX ADVANTAGES

For Illustrative Purposes only:

  • Below is an example of how taxes could be expected to erode the 1 year return of a Canadian Price Return Index ETF that uses the traditional method of holding the physical securities in order to replicate index returns.

Initial Investment $1,000,000

# of Units 100,000

Dividend Tax Rate* 26.57%

Return of Canadian Price Return Index ETF 15%

Index Yield 2%

Total Income Distributions $20,000

Tax Liability ($20,000 X 26.57%) $5,314

Total Return (Return + Dividends)** $170,000 or 17%

After Tax Return** $164,686 or 16.47%

Difference between Total Return

And After Tax Return** $5.314 or 0.53%

*Highest Marginal Tax Rate for Ontario Resident **Based on initial investment amount or price of $10.00

tax advantages on foreign equities
TAX ADVANTAGES ON FOREIGN EQUITIES

For Illustrative Purposes only:

Below is an example of how, if held in a non-registered account, taxes could be expected to erode the 1 year return of a foreign index ETF that uses the traditional method of holding the physical securities in order to replicate index returns.

Initial Investment $1,000,000

# of Units 100,000

Tax Rate* (Foreign dividends taxed as income) 46.41%

Return of US Price Return Index ETF 15%

Index Yield 2%

Total Distributions $20,000

Tax Liability** $9,282

Total Return (Return + Dividends)** $170,000 or 17%

Total Gain After Tax Return** $160,718 or 16.07%

Difference between Total Return

And Total Gain After Tax Liability $9,282 or 0.93%

Roughly 5.4% of its total return goes to taxes.

*Highest Marginal Tax Rate for Ontario Resident **Based on initial investment amount or price of $10.00

etfs 1 beta equity indexing
ETFs ≠ 1 BETA EQUITY INDEXING
  • Can also deliver various asset classes & styles to investors
    • Leveraged / Inverse
    • Fixed Income
    • Commodity
    • Currency
    • Custom Indexing
    • Active management
what is an actively managed etf
Like a traditional ETF, but…

Delivers actively managed investment strategy

Managed by an investment professional

Uniquely designed to meet a specific investment objective

Employs a specific investment strategy

WHAT IS AN “ACTIVELY MANAGED ETF”?
actively managed etfs
Actively Managed ETFs
  • Global actively managed ETFs crossed the $4 billion asset mark in March of 2011
    • Includes the first $1 billion dollar active ETF, The PIMCO Enhanced Short Maturity ETF (MINT:NYSE)
  • Huge asset growth potential. U.S. mutual fund industry is $13 trillion versus $1 trillion in ETFs. Majority of mutual fund assets are actively managed.
    • PIMCO has filed for an ETF version of flagship $240 Billion PIMCO Total Return Fund, the world’s largest fixed-income mutual fund.
who offers actively managed etfs
Largely only in the US to date – BIG NAMES have launched or been receipted

PIMCO

Eaton Vance

State Street Global Advisors

Powershares

Wisdom Tree

Alliance Bernstein

Northern Trust

BlackRock iShares

Russell Investments

Legg Mason

WHO OFFERS ACTIVELY MANAGED ETFS?

Source: etfshub.com

summary
SUMMARY
  • ETFs are efficient
    • Cheaper
    • Faster
    • Relatively tax efficient
  • ETFs provide access to passive benchmarks and active strategies
  • ETFs are intelligent solutions for many investors
disclaimer
Commissions, trailing commissions, management fees and expenses all may be associated with an investment in the Horizons AlphaPro Funds and Exchange Traded Funds (the “AlphaPro Investment Funds"). The AlphaPro Investment Funds are not guaranteed, their values change frequently and past performance may not be repeated. The Horizons AlphaPro S&P/TSX 60 130/30™ ETF, the Horizons AlphaPro Gartman ETF, the Horizons AlphaPro Seasonal Rotation ETF and the Horizons AlphaPro Fiera Tactical Bond Fund may each have exposure to leveraged investment techniques that magnify gains and losses and which may result in greater volatility in value and could be subject to aggressive investment risk and price volatility risk, which are described in their respective prospectuses. "Standard & Poor\'s®" and "S&P®" are registered trademarks of Standard & Poor’s Financial Services LLC (“S&P”) and "TSX®" is a registered trademark of the TSX Inc. (“TSX”). These marks have been licensed for use by AlphaPro Management Inc. The AlphaPro Investment Funds are not sponsored, endorsed, sold, or promoted by S&P or TSX or their affiliated companies and none of these parties make any representation, warranty or condition regarding the advisability of buying, selling or holding units/shares in the AlphaPro Investment Funds. Complete trademark and servicemark information is available at www.hapetfs.com/pub/en/Trademark.aspx. Please read the prospectus before investing.DISCLAIMER
disclaimer27
The Horizons BetaPro exchange traded funds (“HBP ETFs”) consist of the Horizons BetaPro Bull Plus and Bear Plus ETFs ("HBP Plus ETFs"), Spread ETFs (“HBP Spread ETFs”), Inverse ETFs (“HBP Inverse ETFs”) and Single ETFs (“HBP Single ETFs”). The HBP Plus ETFs use leveraged investment techniques that magnify gains and losses and result in greater volatility in value. The Spread ETFs , which combine long and short exposure, also use leveraged investment techniques that magnify gains and losses and which may result in greater volatility in value. HBP Plus ETFs and HBP Spread ETFs are subject to leverage risk and all of the HBP ETFs are subject to aggressive investment risk and price volatility risk, which are described in the HBP ETFs prospectus. Each HBP Plus 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 HBP Spread ETF seeks a return, before fees and expenses, that is the sum of 100% of the performance of one Target plus -100% of the performance of a second Target for a single day. Each HBP Single ETF or HBP Inverse ETF seeks a return that is 100% or - 100%, respectively, of the performance of a Target. Due to the compounding of daily returns, an HBP Plus ETFs, HBP Spread ETFs or HBP Inverse ETFs 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 HBP ETFs whose Target is the S&P 500 VIX Short-Term Futures IndexTM (the “HBP VIX ETFs”), one of which is an HBP Plus ETF and one of which is an HBP Single ETF, are speculative investment tools that are not conventional investments as described in the HBP VIX ETFs’ prospectus. The HBP VIX ETFs’ Target is highly volatile. As a result, the HBP VIX ETFs are not generally viewed as stand-alone long-term investments. Historically, the HBP VIX ETFs’ Target has tended to revert to a historical mean. As a result, the performance of the HBP VIX ETFs’ Target is expected to be negative over the longer term and neither the HBP 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. Commissions, management fees and expenses all may be associated with the HBP ETFs. The HBP ETFs are not guaranteed, their values change frequently and past performance may not be repeated. "Standard & Poor\'s®" and "S&P®" are registered trademarks of Standard & Poor’s Financial Services LLC (“S&P”) and "TSX®" is a registered trademark of the TSX Inc. (“TSX”). These marks have been licensed for use by BetaPro Management Inc. The HBP ETFs are not sponsored, endorsed, sold, or promoted by S&P or TSX and their affiliated companies and none of these parties make any representation, warranty or condition regarding the advisability of buying, selling and holding units/shares in the HBP ETFs.All trademarks/service marks are registered by their respective owners and licensed for use by BetaPro Management Inc. and none of the owners thereof or any of their affiliates sponsor, endorse, sell, promote or make any representation regarding the advisability of investing in the HBP ETFs.Complete trademark and service-mark information is available at www.hbpetfs.com/pub/en/Trademark.aspx. Please read the prospectus before investing.DISCLAIMER
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