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

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
2
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


3
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
Putting Cash To Work





4
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)
RIM: A Case Study
RIM Versus S&P/TSX Capped Information Technology Fund (XIT)
160
RIM
XIT
140
XIT: -7.12%
120
100
80
60
RIM is still 22% of S&P/TSX Capped Information Technology
Index
40
RIM: -57.31%
20
5
Source: Bloomberg from September 29, 2010 to September 29, 2011
9/28/11
9/14/11
8/31/11
8/17/11
8/3/11
7/20/11
7/6/11
6/22/11
6/8/11
5/25/11
5/11/11
4/27/11
4/13/11
3/30/11
3/16/11
3/2/11
2/16/11
2/2/11
1/19/11
1/5/11
12/22/10
12/8/10
11/24/10
11/10/10
10/27/10
10/13/10
9/29/10
0
Tax Loss Harvesting
For Illustrative Purposes Only
6

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
 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
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STRUCTURAL EVOLUTION
SYNTHETIC ETFs
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.
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ETFs 3.0: Total Return Swap
Equity
Index
ETF
Obligated to
deliver
precise index
returns
10
Counterparty
(Financial Institution)
Hedges
exposure
Growth of Swap-Based ETFs
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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. Swapbacked 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
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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
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IMPACT OF A LOWER NEGATIVE TRACKING ERROR
Initial
Investment
($)
Annual return
of benchmark
index
Annual
tracking
error
Terminal
value*
($)
Difference
vs. Fund A
Terminal
Value ($)
Fund A
1,000,000
10%
(0.07%)
2,701,164.35
-
Fund B
1,000,000
10%
(0.15%)
2,679,635.30
(21,529)
Fund C
1,000,000
10%
(0.30%)
2,639,729.64
(61,435)
Fund D
1,000,000
10%
(0.45%)
2,600,418.10
(100,746)
Difference of return over 10 years
* Compounded daily total return over 10 years.
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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.
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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.
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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
Index Yield
Total Income Distributions
Tax Liability ($20,000 X 26.57%)
Total Return (Return + Dividends)**
After Tax Return**
Difference between Total Return
And After Tax Return**
*Highest Marginal Tax Rate for Ontario Resident
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**Based on initial investment amount or price of $10.00
15%
2%
$20,000
$5,314
$170,000 or 17%
$164,686 or 16.47%
$5.314 or 0.53%
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
# of Units
100,000
Tax Rate* (Foreign dividends taxed as income)
46.41%
Return of US Price Return Index ETF
Index Yield
Total Distributions
Tax Liability**
Total Return (Return + Dividends)**
Total Gain After Tax Return**
Difference between Total Return
And Total Gain After Tax Liability
*Highest
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$1,000,000
15%
2%
$20,000
$9,282
$170,000 or 17%
$160,718 or 16.07%
$9,282 or 0.93%
Marginal Tax Rate for Ontario Resident **Based on initial investment amount or price of $10.00
Roughly 5.4% of its total return
goes to taxes.
ETFs ≠ 1 BETA EQUITY INDEXING
 Can also deliver various asset classes & styles to investors
 Leveraged / Inverse
 Fixed Income
 Commodity
 Currency
 Custom Indexing
 Active management
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WHAT IS AN
“ACTIVELY MANAGED ETF”?
THINGS DO GET BETTER AND CHEAPER
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WHAT IS AN “ACTIVELY MANAGED ETF”?
Like a traditional ETF, but…




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Delivers actively managed investment strategy
Managed by an investment professional
Uniquely designed to meet a specific investment objective
Employs a specific investment strategy
Actively Managed ETFs

Global actively managed ETFs crossed the $4 billion asset mark in March of 2011
•

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.
•
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Includes the first $1 billion dollar active ETF, The PIMCO Enhanced Short
Maturity ETF (MINT:NYSE)
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
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
PIMCO
Eaton Vance
State Street Global Advisors
Powershares
Wisdom Tree
Alliance Bernstein
Northern Trust
BlackRock iShares
Russell Investments
Legg Mason
Source: etfshub.com
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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
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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.
26
DISCLAIMER
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.
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THANK YOU!