Horizons BetaPro is following up its recent launch of an ETF that tracks the TSX 60 index (see post Horizons BetaPro S&P/TSX 60 ETF (HXT): Cheap but not simple) with another product that tracks the S&P 500 (C$ hedged) Index. The ETF, ticker symbol, HXS, will employ the same total return structured swap that HXT did. Under the total return swap, BetaPro will invest HXS assets in cash and swap the returns on its cash position for the total returns of the S&P 500 (C$ hedged) index with a counterparty.
HXS will charge a management fee of 15 basis points. Add in HST and the total MER for the new ETF should less than 17 basis points. There is a further swap fee of 30 basis points. The all-in expenses of HXS will be roughly 47 basis points.
While at first glance, it appears that holding HXS will cost roughly twice the Management Fee of 24 basis points charged by the iShares S&P 500 C$ Hedged ETF (XSP), investors should keep in mind that HXS avoids two huge problems with XSP. First, an investor holding XSP in a registered account will incur a 15% withholding tax hit. Assuming a 2% dividend yield, the withholding tax will mean the investor has incurred a roughly 30 basis points expense. If an investor is in the top tax bracket and holds XSP in a taxable account, she will incur an annual income tax hit of roughly 1% (assuming 50% tax rate on a 2% dividend yield). In both these cases, investors should consider holding HXS. Second, by virtue of a the total return swap, HXS will track the S&P 500 (C$ hedged) Index pretty closely. XSP, on the other hand, has a horrendous record when it comes to tracking the index.
It is important to note that HXS will not track the S&P 500 total return in US dollars perfectly for the simple reason that it tracks the S&P 500 (C$ Hedged) Index. Therefore investors can expect HXS to display significant tracking errors to the S&P 500 Index (in US$ terms) due to low correlation between equities and currencies. One recent study estimated that currency effects would have resulted in a tracking error of 40 basis points in the 1980 to 2009 time period.
On the downside, HXS has some limited risk because it depends on the counterparty to deliver the exact return of the S&P 500 (C$ hedged) index. Also, investors should note that there may be some credit risk in the cash and cash equivalents held by HXS unless the assets are invested solely in Government of Canada securities.
In my opinion, HXS’s tax benefits make it a strong competitor to XSP. Since I personally obtain all my US stock market exposure through the Vanguard Total Market ETF (VTI) mostly held in registered accounts, I’m on a wait-and-watch mode on this new ETF. Nevertheless, Horizons BetaPro should be applauded for introducing another innovative, low-cost, new product in the ETF marketplace.
