Horizons ETFs Management (Canada) Inc. launched three new total return ETFs on Thursday, including one that received the most seed capital in Canadian history, the Toronto-based firm said.
According to the initial public offering of Horizons S&P/TSX Capped Composite Index, there are 40 million shares at a price of $25 available at launch, meaning it received a $1 billion seed. The entirety of that funding was received from CIBC World Markets, the firm said.
“It’s extraordinarily gratifying,” Mark Noble, Horizons’ senior vice-president of ETF strategy, said. “This immediately becomes one of our largest ETFs and puts us on pace to be one of the largest ETFs in Canada.”
ETF issuers cannot launch new products without seed capital to fund the initial shares that hit the market. Market makers, Noble said, will seed ETFs in anticipation of how many units they can then sell on the secondary market. He compared the process to when a wholesaler pre-orders a significant amount of product to boost their inventory because they believe sales will be high.
“Getting this kind of seed is a stamp of validation that by day one the institutional market makers expect there to be a lot of interest in this ETF,” Noble said.
Most ETFs in Canada start with $5 million to $10 million in seed capital. When ETFs exceed this number out of the gate, it’s a telltale sign that a large institutional investor is incredibly interested.
The RBC Vision Women’s Leadership MSCI Canada Index ETF launched with $100 million in funding that was provided by the Ontario Municipal Employees Retirement System. In 2012, the Caisse de depot et placement du Quebec provided $30 million to jumpstart the XTF Morningstar National Bank Quebec Index ETF.
It’s rare to see ETFs launch with even a nine-figure seed, Daniel Straus, National Bank of Canada vice president of ETFs and financial products research, said. Straus pointed to the Franklin FTSE U.S. Index ETF and the Franklin FTSE Canada All Cap Index ETF which both hit the market with $250 million each. Horizons Active Corporate Bond ETF was also a top-seeding ETF when it came to market in 2010 with $150 million.
The Horizons S&P/TSX Capped Composite Index ETF uses a total return swap structure, meaning that it doesn’t directly hold securities but is still able to provide the same performance through an agreement with a bank. It’s also able to replicate the total returns of the index without actually paying out dividend income. Instead, those dividends are reinvested back into the net asset value of the ETF.
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Investors using non-registered accounts benefit because the extra return they would normally receive from dividend distributions is instead treated as capital gains, meaning that they do not have to pay taxes that are sometimes in excess of 30 per cent. Any tax liability would be squarely placed on capital gains once shares are sold.
There’s significant investor interest in the total returns strategy, Noble said, and it was the fastest-growing part of its business going into 2019 before the federal government targeted what it called the “unfair tax advantages” of swap-based ETFs in its budget that year. The Canada Revenue Agency, Noble said, believed there was some slippage among market makers in paying the full tax required and would no longer allow firms like Horizons to over-allocate to them.
Horizons saw most of its subscriptions on ETFs using this strategy put on hold until it solved the issue by switching to a corporate class structure that aggregates gains and losses across its lineup of total return ETFs, Noble said.
Along with the Horizons S&P/TSX Capped Composite Index ETF, the firm launched the Horizons Cash Maximizer ETF, which invests directly in high interest savings accounts that pay out 2.25 per cent in annual interest, minus a 0.18 management fee. This ETF also hit the market with particularly high seed capital of $100 million.
Horizons also launched a third total return U.S. large cap index ETF.
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