Investing

Thoughts on swap-based ETFs in taxable acct

  • Last Updated:
  • Mar 26th, 2017 1:49 pm
Sr. Member
Nov 13, 2013
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S5 wrote:
Mar 15th, 2017 7:17 pm
The ETFs do not own shares in the index they are following. Instead they engage a counterparty in a swap agreement. If the counterparty were to go bankrupt or not be in a position to meet its obligations any amount owed to the ETF at that point would not get paid. Canadian regulations don't allow either party to owe the other more than 10% so only that part should be at risk. Moreover the likelihood that a bank would fail in a rising market seems very low. A counterparty failing during a market collapse is not an issue as the ETF would be owing.

More likely is regulatory risk, the government could decide to outlaw these products at any point in time on a whim as they've done with other ones. That would likely lead to shareholders realizing capital gains much earlier than they planned and could lead to some ugly tax consequences.
How risky this is to you depends on your personal situation. If you are in your 50s in a high tax bracket but have no pension and plan to realize the capital gains in retirement when you have almost no income sure the tax hit will not be ideal. Of course, if this is your situation the tax savings of the product are even higher that advertised. Personally I don't expect my retirement income to be much lower than now so could handle a forced capital gains at any point.
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The biggest advantage to capital gains in many cases is tax deferral. There is substantial value in accumulating wealth without the yearly grind of dividend or other income taxes when using a passive strategy stretching decades.

Indeed each situation is different. I'm not advocating for or against these products, just trying to help address questions so RFDers can make informed decisions.
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S5 wrote:
Mar 16th, 2017 7:24 pm
That's a year old press release.Winking Face
So it's 0.1% + swap fee up to 0.3%?

It's a lot more expensive than non-swap based S&P500 ETFs then.
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Feb 13, 2009
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HXS sales pitch is that, 0.3% swap fee is still less than, perhaps 0.5% paid to CRA (assuming annual interests of 2% in VFV or ZSP),
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cn_habs wrote:
Mar 17th, 2017 7:34 pm
So it's 0.1% + swap fee up to 0.3%?

It's a lot more expensive than non-swap based S&P500 ETFs then.
Pretty sure I said as much in my first reply to this thread.

At 2% foreign dividend yield taxed as income that's a 1% yearly grind in taxes at top bracket. Swap fee looks cheap next to that but will lead to higher capital gains taxes on disposition.
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cn_habs wrote:
Mar 17th, 2017 7:34 pm
So it's 0.1% + swap fee up to 0.3%?

It's a lot more expensive than non-swap based S&P500 ETFs then.
The 0.3% swap fee is mean to compensate for the withholding tax the US government assesses on dividends paid in non-retirement accounts held by non-residents. 15% withholding tax on approx 2% dividend yield in the S&P500 =~0.3%.
Invest your time actively and your money passively.
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Deepwater wrote:
Mar 17th, 2017 11:07 pm
The 0.3% swap fee is mean to compensate for the withholding tax the US government assesses on dividends paid in non-retirement accounts held by non-residents. 15% withholding tax on approx 2% dividend yield in the S&P500 =~0.3%.
Not sure what you are trying to say here, can you explain? The US withholding tax is fully recoverable through the federal foreign tax credit for most Canadian tax filers.
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S5 wrote:
Mar 18th, 2017 12:25 am
Not sure what you are trying to say here, can you explain? The US withholding tax is fully recoverable through the federal foreign tax credit for most Canadian tax filers.
The counterparty is required to pay HXS the total return of the S&P500. But if the counterparty invests in the S&P500 its return will be the total return of the index less withholding taxes. The swap fee is paid to the counterparty to cover that. Otherwise the counterparty would have no compensation for the FWT they pay.

Does anyone have a T3 for HXS to see if the withholding tax gets reported in Box 34 - Foreign Non-Business Income Tax Paid in order to make it recoverable by the investor?
Invest your time actively and your money passively.
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Deepwater wrote:
Mar 18th, 2017 10:42 am
The counterparty is required to pay HXS the total return of the S&P500. But if the counterparty invests in the S&P500 its return will be the total return of the index less withholding taxes. The swap fee is paid to the counterparty to cover that. Otherwise the counterparty would have no compensation for the FWT they pay.
Do you have a source for this info? I don't believe the cause and effect you are attributing to the swap fee and FWT has merit. Moreover I'm not sure the counterparty even has to pay FWT or if they do, they are likely able to recover it. Personal tax rules don't apply.
Does anyone have a T3 for HXS to see if the withholding tax gets reported in Box 34 - Foreign Non-Business Income Tax Paid in order to make it recoverable by the investor?
There are no T3s, HXS has never had a distribution.
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S5 wrote:
Mar 18th, 2017 11:26 am
Do you have a source for this info? I don't believe the cause and effect you are attributing to the swap fee and FWT has merit. Moreover I'm not sure the counterparty even has to pay FWT or if they do, they are likely able to recover it. Personal tax rules don't apply.
I have not seen it definitively stated in Horizons documents. But the conclusion is based on a number of items:
  • The prospectus states "Under the current Swap for Horizons HXS, and the proposed Swap for Horizons HSH, each ETF pays, or will pay, to the Counterparty, monthly in arrears, a net amount equal to no more than 0.30% per annum of the notional value of the Swap calculated and applied daily in arrears."
  • So we know the swap fee is paid to the counterparty, not retained by Horizons. Logically it is there to cover some cost incurred by the counterparty.
  • In this Canadian Couch Potato post a VP from Horizons ETFs answered the following question:
    Why does HXS charge a swap fee of 30 basis points, while HXT charges no such fee?

    JP: Just like Canadian retail investors, Canadian financial institutions don’t get as favourable a treatment on US dividends as they do on Canadian dividends, so that’s why they have to pass on some costs to investors.
  • Clearly Horizons attributes it to costs incurred on US dividends.

Maybe Horizons is blowing smoke and overlaying an unjustified 0.3% cost but would that really survive in the competitive ETF marketplace?

I used to own HXT, but never owned HXS because the documentation on it is so vague.
Invest your time actively and your money passively.
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Thanks for the explanation. It is clear that an additional sweetener is necessary for the counterparty in non Canadian domiciled dividend situations. However I still think you are mistaken in attributing the swap fee to FWT.

With HXT the counterparty has a tax benefit which motivates them to offer the swap without a fee and from all accounts finding other counterparties to enter into similar swaps would not be a problem. There doesn't seem to be any tax benefit with foreign holdings so the swap fee seems to be there as a profit incentive for the counterparty in the absence of tax arbitrage. This explanation jives with what the Horizon VP stated.
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RCML27 wrote:
Mar 16th, 2017 12:09 am
Can't I just use the average cost per share/unit that's stated in my trading account statement online as the cost of acquisition when I decide to sell? Isn't this the ACB? If it is, then it makes life easier when reporting capital gains and losses because the bank or brokerage company has already done the calculations for you.
Average purchase price is part of it. If you're in a dividend re-investment plan it also gets more confusing. And more confusing still are return of capital or "phantom" distributions from ETFs. These distributions lower your ACB and should be accounted for.
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