Ask the Spud: Reverse Share Splits in ETFs

Q: I noticed the unit price of some iShares ETFs changed radically last week. For example, the iShares MSCI Singapore ETF (EWS) shot up from around $10 to $20 overnight on November 7. Another fund went from $14 to over $28. What’s going on here, and how would it affect investors? — Chris

If you wake up to find the unit price of your ETF doubled overnight, you might be tempted to think you just scored a 100% return while you slept. But unless you’re an eternal optimist, you’ll probably realize that isn’t the case. What’s happened here is called a reverse share split, or consolidation. Although the price per share of these iShares ETFs doubled (or in some cases quadrupled), the total value of each investor’s holding hasn’t changed, because they now own correspondingly fewer units.

If you’ve ever traded stocks, you’re probably more familiar with a regular stock split, whereby a company increases its number of outstanding shares by some multiple, reducing the price of each share by a proportional amount. A company with one billion shares trading at $100 might undergo a 4-for-1 split, creating four billion shares trading at $25. Each shareholder now holds four times as many shares, but each is worth a quarter as much, so they haven’t gained or lost a thing, and the company’s overall market capitalization remains the same at $100 billion.

Companies may do a stock split to reduce a share price that has climbed so high it’s difficult to trade in small amounts. To give an extreme example, Berkshire Hathaway split its Class B shares 50-for-1 in January 2010 to reduce its price from about $3,500 to about $70, making it more accessible to small investors. The move also helped Warren Buffet’s company get membership in the S&P 500 index.

ETFs sometimes undergo unit splits as well. Back in 2008, BlackRock did a 4-for-1 split on its flagship ETFs, the iShares S&P/TSX 60 (XIU) and the iShares Core S&P/TSX Capped Composite (XIC), as well as several others. Horizons does it relatively frequently. According to the Horizons website: “As a general rule of thumb, the decision to split units of an ETF would occur with unit values greater than or equal to $40. The split makes it easier for an investor to afford and trade 100 share board lots. Without the split, lower trading volumes may occur.”

Coming together

So now we know why companies and ETFs split their shares. But why would they consolidate them, causing the unit price to double, triple or quadruple? If a split is good for investors, isn’t a reverse split a bad sign?

When a company does a consolidation, it is indeed often viewed in negative light. It usually follows a period where the share price has plummeted and the company is in jeopardy of being delisted from the stock exchange. It looks desperate, and investors often put more selling pressure on the stock, driving its price down further. But it turns out that with ETFs, reverse splits are often good for investors.

To understand why, remember that ETFs, like stocks, have two prices: the ask price is what you’ll pay to purchase shares, and the bid price (which is always lower) is the amount you’ll receive when you sell. The difference between the two—called the bid-ask spread—is a cost borne by both the buyer and the seller. In general, the higher an ETF’s share price, the tighter the spread will be.

Let’s say you want to buy $10,000 worth of an ETF with a bid of $19.99 and an ask of $20.01, for a spread of two cents. If you buy 500 shares, that spread amounts to $10, a cost split equally by you and the party on the other side of the trade.

Now consider this ETF after undergoing a 1-for-2 reverse split. Assuming it keeps the same two-cent spread, it would begin trading with a $39.99 bid and a $40.01 ask. To buy $10,000 worth you now need only 250 shares, so the bid-ask spread would be just $5.

A reverse split is also likely to benefit investors whose brokerages charge ECN fees, such as Questrade and Virtual Brokers. These are charged on a per-share basis, regardless of the ETF’s unit price. (To be fair, they are a fraction of a cent per share, so any savings would be trivial except on huge trades.) If you pay trading commission on a per-share basis—which is unusual at online brokerages, but may apply if you use an advisor—you’re also clearly better off with an ETF sporting a higher unit price.

And what happens if you own an odd number of shares when your ETF undergoes a reverse split? Not to worry. The oddball share will just be redeemed at its net asset value. So if you own 201 shares trading at $50 and they undergo a 1-for-2 consolidation, you’ll end up with 100 shares worth $100 each, plus $50 in cash.

 

22 Responses to Ask the Spud: Reverse Share Splits in ETFs

  1. Paul G. November 15, 2016 at 8:56 am #

    Having 50$ redeemed would be a pain for anyone looking to just keep their whole portfolio as simple as possible, and as simple to manage as possible.

    I know it’s not a big deal as such, but still a pain to have to keep that in mind.

  2. Canadian Couch Potato November 15, 2016 at 10:13 am #

    @Paul: Is it any different from receiving a $50 dividend? All ETF portfolios will inevitably have a cash balance from distributions.

  3. Tyler November 15, 2016 at 12:31 pm #

    Hi Dan, in a taxable account, would the automatic redemption of the oddball share lead a taxable capital gain for that year, or does it somehow just get rolled into the adjusted cost base?

    Thanks

  4. Canadian Couch Potato November 15, 2016 at 12:45 pm #

    @Tyler: It would be taxable gain (or loss), but the amount would almost certainly be tiny.

  5. Paul G. November 15, 2016 at 12:55 pm #

    @CCP: Well, it might mean a 10$ capital gain, which means you have to deal with the paperwork (which is the same for any gain).

  6. CharlieFox November 15, 2016 at 8:00 pm #

    Ah. Thanks for mentioning horizons funds. I was wondering what would happen if it kept going up (cause the dividends would keep pushing it up).

  7. Diego Revere November 16, 2016 at 1:05 pm #

    I was actually wondering about a topic you touched on in the article as it applies to Norbert’s Gambit. If you are exchanging a large amount of CAD to USD (or vice versa), I reason it would make sense to use a cross-listed stock which has a high stock price, a low bid-ask spread, a high trading volume and isn’t super volatile. You answered one of my questions in this article:

    You would have a lower bid-ask spread doing Norbert’s Gambit with a more expensive stock (ie RY(TSX)/RY(NYSE) vs DLR/DLR.U (both on TSX), right?

    But a few related questions I had would be …

    Is there any tax disadvantage/advantage to trading on the two exchanges (ie. using something like RY) rather than both on the TSX (ie DLR)? So basically, are capital gains taxed the same in all accounts (corporate, personal, TFSA, RRSP) on both exchanges?

    When the stock doesn’t change price during the entire Norbert’s Gambit execution, there would be a definite small capital loss (due to bid-ask spread). Technically, this small loss should offset any current or future capital gains, thus making Norbert’s Gambit even more cost effect than simply exchanging through a bank, right?

    I guess one answer to these questions is that these amounts of money are trivial when you are doing Norbert’s Gambit, so the fine details don’t matter much. I know this site doesn’t promote picking individual stocks, but I bet a lot of investors have stocks which are listed on more than one exchange and if they are selling to transition to index style investing, this could help them decide if they want to buy something like VUN vs VTI.

    By the way, I have really been enjoying your blog for many years now. Thank you for all your hard work. I have really appreciated Justin Bender’s writings too.

  8. Paul G. November 16, 2016 at 5:17 pm #

    @Diego Revere: I once got a nasty little letter for Revenu Quebec concerning potential undeclared capital losses and gains going through Norbert’s gambit (I had sold things and wasn’t declaring a loss or a gain), and as such I no longer want to make such trades outside of registered accounts, so those capital losses aren’t applicable to future gains.

  9. Canadian Couch Potato November 16, 2016 at 10:07 pm #

    @Diego: Thanks for the comment. You raise two good questions here.

    The first point has to do with using an inter-listed stock to do Norbert’s gambit rather than DLR. You are correct that such stocks typically have tighter bid-ask spreads than DLR, so it would be cheaper. However, with an inter-listed stock you introduce a whole new risk: i.e. that the stock will move significantly during the interval between the by and sell trades. If you use a brokerage like RBC Direct or BMO InvestorLine you can usually place the two trades within a minute of each other, so this risk is small. But I would strongly advise against it if the brokerage makes you wait for the first trade to settle before making the second (this is the case at Scotia iTRADE and Questrade, among others).

    To answer the second question regarding taxes, you are correct that gains or losses would be reported the same way whether both trades are done on the TSX or one is done on a US exchange. Full details here:
    http://canadiancouchpotato.com/2015/02/26/taxable-consequences-of-norberts-gambit/

  10. Su-Chong Lim November 17, 2016 at 10:46 pm #

    @Paul G: It wasn’t clear in your brief reference why Rev Quebec considered that there might be potential capital gain. Obviously outside a registered account any significant (i.e. more than $200 as far as Rev Can is concerned) capital gain would be subject to taxation.

    But if you did the Norbert’s Gambit as was specified above on a cross-listed stock on the Toronto and NY exchanges, such as RY or TD, and you completed the whole buy-sell cycle within minutes or even seconds, then the stock would not have budged in value and the only CAD-USD dollar equivalent you got back per share would be, by simple mathematics, and by the magic of arbitrage, the same amount as defined by the spot exchange rate, minus half the bid-ask spread times two ( i.e the bid-ask spread). Thus, if you got back essentially the same value in the other currency, there can’t be a capital gain. The paper trail you generate would prove that, wouldn’t it?

  11. Paul G. November 18, 2016 at 1:29 pm #

    @Su-Chong Lim : Yes, the paper trail did show negligible capital loss, but I hadn’t filed any paperwork since to me it was a 1 for 1 currency exchange. From their point of view, I sold stocks and didn’t declare a gain or loss, and as such it seemed suspicious.

    They were also suspicious of my having transfered ETF shares in kind to my TFSA without declaring capital gains or losses (I had bought them minutes before, and so there was essentially no gain or loss).

    In short, Revenue Quebec can get very suspicious, very quickly. Thankfully the person I dealt with quickly understood and didn’t pursue the matter after seeing my paperwork showed there was nothing much to speak of.

    Just to keep things very simple, since then I do Norberts inside my registered accounts and only contribute plain old Canadian dollars to fund my RRSP annd my TFSA. I thought I was being smart by paying the 10$ transaction fees before contributing, to best use our limited contribution room, but to me it’s not worth the hassle and the worry that a paranoid Revenu Quebec or Revenu Canada might come and ask for paperwork. (ie – I know I’m doing nothing wrong, but I don’t want to have to prove that I’m doing nothing wrong).

  12. Su-Chong Lim November 18, 2016 at 2:12 pm #

    @Paul G. I hear you! It’s a sad state of affairs that law abiding citizens have to avoid legitimate transactions that may look suspicious to uneducated authorities, even though the paper trail can always easily prove that nothing nefarious was intended or achieved.

  13. Que November 19, 2016 at 10:50 am #

    @Dan: who pockets the bid ask spread?

  14. Canadian Couch Potato November 20, 2016 at 3:36 pm #

    @Que: The market makers are typically the beneficiaries. They ensure there is enough liquidity in the marketplace and are compensated by taking a small part of every transaction.

  15. Jason C. November 22, 2016 at 6:14 pm #

    Hi Dan,

    I started index investing about three years ago and acquired some knowledge by reading several books written by the American authors. I have benefited quite a lot from you when applying those principles to our Canadian market. I really appreciate all the information you provide on this site. Great job Dan!

    Given this thread mentioned Norbert’s gambit, I would like to provide some information in respect of this issue. I am always doing my banking with CIBC. Today I receive a letter from them, advising that the clients with CIBC will be able to hold certain foreign currencies and foreign denominated investments in RRSPs, RRIFs and TFSAs effective on January 23, 2017. I am very pleased to see these changes, though the CIBC Investor’s Edge trading services representative is unable to provide any details for the coming adjustment at this point through the telephone.

    You may have known the above information. I hope to read an update from you and Justin Bender on your Norbert’s gambit white paper for CIBC Investor’s Edge some time next year!

    Thanks,

    Jason

  16. Canadian Couch Potato November 22, 2016 at 8:21 pm #

    @Jason C: Thanks for the comment, and glad you’re enjoying the blog. Yes, we had heard about this coming change at CIBC. As you may know, right now CIBC seems to offer currency conversion at a rate very close to the spot rate in RRSPs. This actually makes Norbert’s gambit unnecessary at Investor’s Edge. They don’t make this very public, but I think the idea is they recognize they are now one of only a few brokerages not to allow USD in registered accounts, so they are attempting to reduce the impact of this decision on their clients. Glad to see they are now going all the away and offering USD accounts.

    Justin recently launched a YouTube channel with instructional videos for all of the major discount brokerages. Over the next several months he’s going to be doing a series of tutorials on Norbert’s gambit, as well as several other processes, so watch for it here:
    https://www.youtube.com/channel/UC3AXuQUdd-oBmMseUu2VFHg

  17. Jason C. November 22, 2016 at 9:37 pm #

    @Dan: Thank you Dan for your prompt response.
    My only USD holding is VBR. I bought it in early 2014, which might be the reason why I did not know that CIBC converts currency very close to the spot rate in RRSPs. I assume that a lot of investors are still using Norbert’s gambit at Investor’s Edge now, because the CIBC trading services representative I talked with this afternoon advised that the coming change will significantly reduce their workload of FX netting.
    Anyhow, thank you again for your clarification. Also, many thanks to Justin for his Youtube channel.

  18. Louis November 22, 2016 at 11:53 pm #

    @CCP: Has BMO Investorline changed the way they handle Norberts Gambit using DLR and DLR.U? Your prior tutorial and comments imply that we can buy DLR online but have to call a BMO rep and have them journal over to DLR.U and sell them, settling the funds in USD in the account. Is there a way we can do the whole procedure online now at Investorline and skip calling a rep? Thanks !

  19. Canadian Couch Potato November 24, 2016 at 10:02 am #

    @Louis: To my knowledge BMO InvestorLine has not changed their policy. You still need to phone them to sell DLR in the currency other than the one in which you bought it. However, if you use an cross-listed stock, you can do this online without a phone call. Just remember that this carries somewhat more risk, as the stock can move in price between the two transactions.

  20. Louis November 24, 2016 at 6:02 pm #

    @CCP: Thanks for the reply Dan!

  21. Jane I December 8, 2016 at 1:56 am #

    Hello,

    I am new here, and have been looking around into how to invest my money wisely. I also bank with CIBC and I am contributing a small amount monthly into TFSA, RRSP, and RESP. My advisor at CIBC advised I put all my money into high interest yielding mutual fund, and I have. But I don’t think that right. First, I would want to diversify my portfolio, and I would like a secured principal . Please can Jason C and anyone advice what you have done in the past investment-wise, and would you recommend stand alone advisor like Edwards Jones or bank ones ?

  22. Peter December 13, 2016 at 1:33 am #

    this happened to me once, took me a while to figure out what happened and now with your explanation, I can explain it to others more easily.

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