Your Complete Guide to Index Investing with Dan Bortolotti

A Tax-Friendly Bond ETF on the Horizon

2017-12-02T23:29:05+00:00May 8th, 2014|Categories: Bonds, New products, Taxes|Tags: , |83 Comments

Bonds should be part of just about every portfolio, but if you have to hold them in a non-registered account the tax consequences can be onerous. Fortunately, Canada’s ETF providers are taking steps to ease that burden with some innovative new products, including an ETF of strip bonds and another that holds only low-coupon discount bonds. The latest entry is the Horizons Canadian Select Universe Bond (HBB), which is set to begin trading this week. HBB is unique: it’s the only bond ETF in North America—and maybe anywhere—that uses a total return swap, which should dramatically improve its tax-efficiency.

The swap structure is the same one used by the Horizons S&P/TSX 60 (HXT) and the Horizons S&P 500 (HXS), which are now more than three years old. Here’s the basic idea: the ETF provider has an agreement with National Bank (called the counterparty) to “swap” the returns of two different portfolios. When you buy units in HBB, Horizons places your money in a cash account and pays the interest to the counterparty. In return, National Bank agrees to pay Horizons an amount equal to the total return of the fund’s index—that means any price change, plus interest payments—minus a 0.15% fee. (This is on top of the 0.15% management fee charged by Horizons, so investors should expect the fund to lag its benchmark by 0.30%, plus a bit more for taxes.)

As an investor in HBB, you therefore have exposure to the bond market, even though you don’t actually own any bonds. This has a couple of important implications. The first is that the ETF won’t pay any cash distributions. More important, you won’t be taxed on the interest each year. That’s because there is no interest: remember, you’re not actually holding any bonds. Investors therefore won’t have any tax liability until they ultimately sell their shares in the ETF, at which point any growth would be taxed as a capital gain.

The potential tax benefit here is significant. A swap-based ETF (like a stock that never pays a dividend) allows the investor to defer taxes indefinitely. And because capital gains are taxed at only half the rate of interest, the investor’s ultimate tax bill could be significantly lower than it would be with a traditional bond fund.

Across the universe

HBB tracks the newly created Solactive Canadian Select Universe Bond Index. The benchmark is similar to the widely followed DEX Universe Bond Index in average term (about 10 years), yield to maturity (about 2.5%) and duration (about 7 years). Both indexes also hold approximately 70% government and 30% corporate bonds, all investment-grade. This means HBB’s pre-tax performance should be very similar to that of the iShares Canadian Universe Bond (XBB) and the BMO Canadian Aggregate Bond (ZAG).

The key difference is that the Solactive index has far fewer bonds: 162 issues, compared with more than 1,300 for the DEX Universe. Tracking a large bond index is difficult and expensive, so index funds pegged to the DEX Universe always use “representative sampling,” selecting a smaller of number bonds with similar overall characteristics. XBB, for example, holds about 800 issues, while smaller funds may hold fewer. The new Solactive index will be easier to replicate in full, while still providing plenty of diversification and liquidity. The index licensing fee is also much lower, which likely helped to keep the management fee down.

What are the risks?

Swap-based ETFs do carry some additional risk investors should understand. The first is counterparty risk: there’s a possibility the counterparty (in this case, National Bank) could fail to deliver the return of the underlying index as promised. Most people would likely agree this risk is small. The probability of a major Canadian bank defaulting seems low, and even if that were to occur, ETF unitholders would not lose their whole investment. Canadian securities law requires mutual funds and ETFs to keep their derivative exposure to no more than 10% of the fund’s assets. At least 90% of the fund’s assets is therefore covered by high-quality collateral. (See my previous posts for more on the risks of swap-based funds from Horizons and synthetic ETFs in general.)

The second risk is that the federal government may decide to crack down on swap-based products. Many investors have asked me about this since the 2013 budget spelled doom for the so-called “Advantaged” ETFs from iShares, which also promised tax-efficient exposure to bonds and foreign equities. No one can predict future government policy, so this is always a possibility, but there are some important differences between total-return swaps and the type of derivative (called a forward contract) used by the Advantaged ETFs. Even if the government did eventually take aim at swap-based ETFs, the likely consequence would simply be that unitholders would have to sell the fund and realize any capital gains immediately.

As always, it’s prudent to take a wait-and-see approach with new products, and to make sure you’re comfortable with the structure of non-traditional ETFs. But if HBB delivers on its promise, it could offer significant benefits for investors who need to hold their fixed income outside registered accounts.

Update: Some clarification from Horizons

After this post was published, I followed up with Horizons regarding the questions raised by readers. Here’s what I learned:

Swaps are different from the forward agreements that were targeted by CRA last year. The forward agreements made an election under Section 39(4) of the Income Tax Act to have their settlement treated as “capital transactions” rather than income gains or losses. These so-called “character conversion transactions” were what the government clamped down on with the 2013 budget announcement.

Swaps do not make this election. Upon settlement of the swap (which can occur any time there is a redemption in the fund), the realized gains are characterized as income. But instead of that income being passed along to individual retail investors, the tax liability is borne by the institutional market makers. The key idea is that no income is being “recharacterized” as capital gains: the market makers and the counterparty do have a tax liability for the income they receive. Presumably as corporations they have the ability to deduct this income as an expense in ways that individual investors do not.

As outlined in the prospectus, there is a possibility that at some point ETF unitholders could receive an income distribution and would be liable for the associated tax. This possibility is remote, however: it would require zero redemptions in the ETF, as well as a significant rise in rates. This is why Horizons ETFs has said they don’t anticipate making any taxable distributions, but cannot guarantee this. The situation is the same with HXS, but so far there have been no distributions in the funds’ three years of existence.



  1. Holger May 8, 2014 at 9:52 am

    Interesting news! The Canadian ETF landscape sure is exciting these days.

    How would such a synthetic bond ETF measure up against traditional bond ETFs in total return performance? Tracking a bond index is one thing, but what about a distribution equivalent?

    Even after tax, bond ETFs distributions still amount to ~2% annually and thus increase total returns. Is the synthetic ETF expected to appreciate above and beyond a bond ETF with distributions?

    If there is no compensating element in the synthetic ETF, I wonder how it would be a better deal compared to bond ETF with (taxed) distributions.

  2. Canadian Couch Potato May 8, 2014 at 10:18 am

    @Holger: The swap will deliver the total return of the underlying index, which includes price changes and the value of any interest payments. So on a pre-tax basis (such as if the ETFs were held in a registered account), the returns of HBB should be very similar to that of a broad-based bond index fund that reinvested all its distributions. (Fees will be factor, of course.) It’s the same situation with HXT and XIU: the dividends are included in both.

  3. ccpfan May 8, 2014 at 10:24 am

    Hi Dan,

    It’s always a pleasure to learn from your blog.

    HBB’s a very interesting addition. I have two questions on such swap ETF products:

    1- Won’t the counterparty have to pay taxes on the interest of the bonds it holds? If so, why would the counterparty agree to pay back HBB the full gross total return, in exchange for just a little interest and a small .15% fee? Is there some tax loophole that allows the counterparty to avoid paying tax on bond interest? I feel that I am missing an important piece of the puzzle, here.

    2- As the money of HBB investors pays interest, won’t HBB investors have to pay taxes on this interest?

  4. Michael James May 8, 2014 at 10:46 am

    It’s true that counterparty risk is small in any given year. But the advantage of this swap-based fund over other bond funds is also small in any given year. To decide whether to buy into such a fund, we need to quantify things. It’s not too difficult to quantify the tax advantage of the swap-based fund. However, quantifying counterparty risk is more difficult. We could start by asking whether we think the counterpary will still be in business in a century. If we decide the odds of this are 50/50 and the consequences of counterparty failure are a 10% loss to investors, then the per-year loss works out to 5 bps (acutally the loss is a little higher because the failure might not come at the end of the century). We might add to this to account for losses due to delays in getting paid in the aftermath of the counterparty’s failure. At 5 bps, this cost is smaller than the tax saving. If we make different assumptions about the likelihood of counterparty failure, things change. I guess my main point is that we shouldn’t just say the risk of counterparty failure is small and move on.

  5. Dan Hallett May 8, 2014 at 10:59 am

    Thanks for the update Dan. I saw that this was coming but had no details until this morning. To Michael’s point, I dug into this in some detail when HXT was first launched. See

  6. Michael James May 8, 2014 at 11:08 am

    @Dan H: Interesting article. I would treat a CDS-based calculation of counterparty risk cost as a minimum cost. One reason for this is because an individual who gores through a counterparty failure might see delays in getting access to money, which could be a hardship. Another reason is that I’d be concerned about the possibility that the current market CDS price does not reflect long-term costs. This is similar to what caused the credit meltdown in 2008-2009.

  7. Richard May 8, 2014 at 11:15 am

    This is very interesting. This could be the most tax-efficient part of a standard portfolio now since it’s better than Canadian dividends. That comes as a surprise.

    National Bank probably won’t be around in 100 years. But that doesn’t mean a guaranteed 10% loss for investors. It will probably go in an acquisition or a merger rather than bankruptcy. Whether or not this happens, it may decide at some time in the distant future not to continue doing this. If a suitable replacement can’t be found then investors will be forced to sell early and restructure their portfolio to move their bond holdings into sheltered accounts. I’m not sure how long the contract is for but in this case investors may have a few years to make the switch.

  8. Canadian Couch Potato May 8, 2014 at 11:35 am

    @ccpfan: This is a great question. As I understand it, the counterparty is responsible for paying the taxes on the underlying bonds. However, as a corporation they are presumably able to deduct this income in ways that individuals cannot. This kind of “tax arbitrage” is also behind the swap-based equity ETFs, as Dan Hallett has written about:

    As for the interest on the cash held by Horizons, that is paid to the counterparty, so it is not taxed in the hands of the ETF holder.

  9. Sixtyplus May 8, 2014 at 11:35 am

    It would be great if they now started a similar fund to track one of the EAFE indexes. Any rumors on one of these?

  10. Jon May 8, 2014 at 12:50 pm

    Hi CCP,

    If I decided to choose this product for my bond allocation, how would that affect my allocation? Would it be better to hold these funds in a nonregistered account over foreign equities? (I’m not planning on changing anything with my bonds right now- just wanted to hear your thoughts)

  11. Canadian Couch Potato May 8, 2014 at 1:01 pm

    @Jon: From an income tax perspective only, a swap-based bond ETF would be more tax-efficient than a traditional foreign equity ETF that paid dividends. But one would have to make the asset location decision based on a number of factors as well.

  12. Jas May 8, 2014 at 1:43 pm

    Do you currently suggest to your wealthy PWL capital clients with significant assets in taxable accounts to use Horizon’s swap-based ETFs ? Thanks

  13. Canadian Couch Potato May 8, 2014 at 1:54 pm

    @Jas: No, PWL Capital does not currently use swap-based ETFs with its clients.

  14. Jim May 8, 2014 at 2:32 pm

    Hi Dan,

    Great article, thanks simplifying such a complex product!

    HBB looks like it might be a good investment for my non-registered bond allocation, but I’m a little worried about the tax implications…. I know you say above that the counterparty is responsible for paying taxes on the interest income from the bonds, but I’m wondering what you make of this (pg 20 of HBB’s prospectus):

    “Regulatory and Tax-Related Risks

    The ETFs will each recognize income under a Swap when it is realized by such ETF upon partial settlements or upon maturity of the Swap. This may result in significant gains being realized by the ETF at such times and such gains would be taxed as ordinary income. To the extent such income is not offset by any available deductions, it would be distributed to applicable Unitholders in the taxation year in which it is realized and included in such Unitholder’s income for the year.”

    It sounds like there’s still a chance somehow that an investor would still pay taxes on the interest income of the bonds, but I’m not sure I understand why. Thanks

  15. Willy May 8, 2014 at 2:45 pm

    Is it wrong that I don’t like these things?

    I get all the potential advantages. And I suppose that if one were in a position where they had a large amount of fixed income that was required to be held in a taxable account, the dollar savings could be substantial. May I be blessed with that problem one day… That said, one of the core mantras (at least for me) in learning about passive investing has been Keep It Simple. Simple strategies, simplify decisions, and simple products. These swap-based creatures strike me as getting awfully close to some line that I feel like I shouldn’t be crossing. Is that weird?

  16. Canadian Couch Potato May 8, 2014 at 3:00 pm

    @Jim: I’m not going to pretend I understand that legalese. I’m going to follow up with Horizons and ask for a plain English translation. (By the way, I think you meant HBB in your comment, not XBB, so I changed it. Let me know if I mus understood.)

    @Willy: I think your position is entirely reasonable. No one should ever invest in a product that makes them uncomfortable just to reduce fees or taxes. I have often made a similar argument in favour of index mutual funds over ETFs: it’s OK to pay a little more for simplicity, because people are more likely to follow through with simple plans.

  17. Jake May 8, 2014 at 4:28 pm

    is there really a market crash coming? I’ve read your moneysense book which says historical stocks returns are up around 9% however for example for 15 year period ending march 31st TDB661 has just return of 1.44% and NBC839 has returned 1.40%. I’m sure if someone put that 40% of the couch potato portfolio money in 5 yr GIC’s 15 years ago with very little risk they’d have a lot more than what US and International stocks have produced. I would think those stocks would sore if historical returns are up at 9% otherwise we could be into a period of 30 yrs, a persons whole working life with very little returns. As you have said we don’t know what the future will bring and can’t predict on future returns. At the end of the day should we just put our hard earned money in GIC’s and sleep well at night? starting out in investing they say to go for growth but boy for someone that’s halfway through to retirement, the 1.44 and 1.40% returns on US and international equities the past 15 years isn’t growth !!!! Am I missing something in my thinking?

  18. Nathan May 8, 2014 at 7:57 pm

    Hey Dan, maybe you can help with this. I have a friend who is a Canadian citizen living abroad indefinitely. He earns USD, is currently living in Europe, and really doesn’t know where he’ll retire eventually (but very likely not Canada). In this situation, it makes the most sense to hold investments in a Canadian brokerage account, but seeing as he doesn’t expect to retire to Canada (at least not any more likely than anywhere else), holding the fixed income portion in CAD doesn’t really make sense. So the question is, what is a good global, tax efficient fixed income investment for a couch potato, which can be purchased in a Canadian brokerage account? The only things I could come up with are things like Vanguard’s US and international bond ETFs, but they’re going to be full of premium bonds, and his account will be taxable (although more favourably than our taxes, as I understand it). I’m not sure whether it’s even possible to buy individual US bonds in a Canadian discount brokerage, but even if so I’d like to find something simpler than that. (And although US would be better than Canadian, global would be ideal.) Any thoughts? I wasn’t able to find any ETFs of international discount bonds, or swap structures with international bonds or anything like that. I wonder if a GIC ladder (or even a tax-efficient Canadian fund like HBB) would still end up being the best option, even with currency exchange and currency risk.

  19. Canadian Couch Potato May 8, 2014 at 8:46 pm

    @Nathan: I’m not aware of any product that fits that description. As you point out there are a few global bond funds listed in the US, but these would be tax inefficient. The innovative tax-efficient ETFs brought out by Canadian providers seem to be unique in North America. DFA has a tax-efficient global bond fund, but it is hedged to Canadian dollars and only available through advisors. And advisors are generally not able to work with non-residents. Sorry I couldn’t be of help.

    It is possible to buy USD term deposits at some Canadian brokerages. They are structured like GICs, but they don’t have CDIC insurance and the rates are very low. At last that would be tax-efficient. :)

  20. Canadian Couch Potato May 8, 2014 at 10:38 pm

    @Jake: You’ve raised some fundamental issues here that can’t be answered in blog comment. But the most important point is that you’ve made enormous generalizations about investing based on the performance of one asset class (US large cap stocks) during one relatively short time period (the last 15 years). No one invested their life savings in the S&P 500 in 1998 and then sold everything at the end of 2013. Investors who held a diversified portfolio over that period would have done just fine: probably between 5% and 7%, which is not bad considering the start date is near the peak of the dot-com bubble the period in questions included the worst market crash since the Great Depression.

  21. Ian May 8, 2014 at 10:47 pm


    Just a guess but seems pretty straight forward:

    As CCP says, National Bank makes tax deductions on the dividends. They pass on those savings (minus their fee) to the swap partner. When National Bank runs out of tax deductions they can’t do that anymore. At this point the etf would have to make a distribution to its investors.

  22. ccpfan May 9, 2014 at 7:41 am

    Dan, thanks for the answer. Unfortunately, I have trouble understanding . I really need a clearer step-by-step explanation of how to product works and what’s in it for each party including the CRA. I don’t believe the CRA will stand unmoving losing tax money to some brilliant loophole.

    So far, I don’t understand swap-based ETFs well enough to be comfortable with them. So, until I get a better understanding, I’ll have to apply my general rule of if it sounds too good to be true, it must be.

  23. Holger May 9, 2014 at 9:15 am

    Swap-based (or synthetic) ETFs are not as esoteric as they might sound. In Europe, 75% of all ETFs and index funds have been swap based for years. It’s only recently that fully replicating funds are becoming more popular there. Here in North America it is the other way around.

    Whether the CRA will leave that loophole unplugged is a different story. In Europe that has never been a problem, because most European tax systems do not differentiate between capital gains and income.

  24. Jim May 9, 2014 at 9:25 am


    Seems like that would defeat the purpose of HBB then, no? What’s the point if I know that I’m going to receive a distribution anyway sometime down the road?

    I guess the next logical question would be whether or not that potential distribution information would be made available ahead of time. I.e. would I be able to sell HBB before any distribution is paid?

  25. Louise May 9, 2014 at 9:34 am

    The timing of the release of yet a new fixed income product seems good, I am in the position that I need to add fixed income but have maxed out my RRSP and TFSA so it needs to go into my taxable account so I have been trying to research the various options.

    With this offering however, my spidy senses are tingling as I think that CRA will not approve due to the different treatment of interest income vs dividends or capital gains. Definitely a case where it sounds too good to be true. Surely Horizons has done some thinking on this before launching? Is there anything that they can share?

  26. gsp May 9, 2014 at 10:31 am

    “I guess the next logical question would be whether or not that potential distribution information would be made available ahead of time. I.e. would I be able to sell HBB before any distribution is paid?”

    It won’t matter. If it is made available everyone else will be in the same boat and the tax consequences will be reflected in the ETF’s price.

  27. Dan Hallett May 9, 2014 at 11:01 am

    @Michael James:

    You are correct that CDS pricing may or may not fairly reflect the risk being undertaken in a structure like this. Clearly prices were unusually low prior to 2008. But my use of CDS quotes was only meant to show how to evaluate if investors were being fairly compensated for the extra risk taken. Even that was a guess since no CDS instruments were available for National Bank at the time that I wrote that blog article.

    So even the approximation I used was more to get people thinking along those lines rather than to attempt some precise credit default calculation. But if you could buy a CDS – as many like Fairfax Financial did – the payoff can be huge if you’re on the right side of the bet. And if you’re properly hedged, there should be no delay in making the investor whole.


    HBB will hold cash and National Bank will hold the representative bond portfolio. Interest generated on each respective portfolio is taxable income to each respective counterparty. For example, National Bank receives taxable interest and will realized capital gains/losses as time marches on.

    The swap is an obligation that requires National Bank to pay to HBB an amount equal to the total return of the bond portfolio. That payment is fully deductible so that on a net basis there is no net tax payable as a result of its bond investments. There is a tiny arbitrage opportunity here to the extent that National Bank sees anything other than interest income from its bond portfolio. But not enough to do this for free – like they do for HXT – so their revenue is the 15 basis point swap fee.

    Same for HBB. It earns interest from the cash held. But it must make a payment to National Bank roughly equal to the total return on its cash so the two cancel out and no taxes are payable on the interest income it receives.

  28. Dan Hallett May 9, 2014 at 11:04 am

    And the CRA risk is very material. The fact that they eliminated the use of equity forwards as a tax re-characterization strategy should raise concern that attacking total return swaps used for the same end goal may not be safe from future tax changes. Horizons believes there is reason to believe it is safe and I’m following up with them to better understand their views on this and any associated tax opinions they have.

  29. Michel May 9, 2014 at 12:23 pm

    for taxable investor, the choice of bond ETF is now:


    each with their own advantages, disadvantages… what a puzzle !

  30. Canadian Couch Potato May 9, 2014 at 2:25 pm

    @Dan H: Many thanks for your input on these questions. I too have asked Horizons for a response and will share whatever I learn. As you point out (and Horizons has explained to me when I asked them directly), there is no tax avoidance here. The counterparty holds the bonds and is responsible for paying the taxes on the interest. That’s not to say there is no chance the CRA will make a ruling on this structure: of course that is always a possibility.

  31. Tyler May 9, 2014 at 5:54 pm

    Michel, don’t forget about GICs… ;) It feels to me like “boring” fixed-income is much harder to figure out than the “exciting” world of equities!

  32. Ian May 9, 2014 at 8:48 pm


    I think the chance of HBB making a distribution is extremely unlikely. HXT has never had to make one.

  33. Oldie May 10, 2014 at 12:44 am

    @Michel: … and don’t forget (ZDB/)BXF.

  34. KayT May 10, 2014 at 10:31 am

    Given the interest rate environment with the likely rise (normalization) in interest rates, I wish Horizon had launch a similar product to HBB that matched the characteristics of a short term bond ETF like XSB.

  35. Dan Hallett May 10, 2014 at 10:36 am

    I’ll be interested to hear their input but I can’t – off hand – think of a meaningful difference between swaps and forwards in this context. I can recall textbooks always describing forward contracts and then they’d simply define swaps as series of back-to-back forwards. When CAB used to use a forward contract for instance, the structure was not much different.

    CAB would buy a basket of stocks and the counterparty would buy bonds. In the same manner, CAB would be taxed on dividends, interest and capital gains but would deduct a payment under the forward contract equal to the total return of the stock portfolio. And then it would add back the payment received from the bank counterparty (equal to the bond portfolio returns).

    Similarly, the bank counterparty would buy the bond portfolio and, accordingly, collect interest income and to a lesser extent some capital gains. The bank would have to include the interest in its taxable income but would deduct its payment to CAB (equal to the bond portfolio’s total return) and add the payment received from CAB.

    There may have been specific provisions dealing with these equity forwards but the basic structure and underlying obligations and exposure seems the same at first blush. I look forward to being enlightened.

  36. ccpfan May 10, 2014 at 11:51 am

    @Dan Hallett:

    “HBB will hold cash and National Bank will hold the representative bond portfolio. Interest generated on each respective portfolio is taxable income to each respective counterparty.[…]
    The swap is an obligation that requires National Bank to pay to HBB an amount equal to the total return of the bond portfolio. That payment is fully deductible so that on a net basis there is no net tax payable as a result of its bond investments. […]
    Same for HBB. It earns interest from the cash held. But it must make a payment to National Bank roughly equal to the total return on its cash so the two cancel out and no taxes are payable on the interest income it receives.”

    So, if I understand right, after all the paper shuffling, the CRA is getting doubly cheated out of tax (on both cash and bond interest). I just don’t understand why the interest on cash can be discounted for both HBB (that receives it and then pays it to the counterparty) and for the counterparty (which receives it from HBB). I also don’t understand how the reverse is true, too, for the interest on bonds.

    I also discover that the bank has to actually borrow as much cash as HBB receives from investors, in order to invest it in bonds and earn interest for the swap contract. Surely, this money is not free to borrow, is it?

    It seems like HBB’s investors are getting a free ride at the expense of both the counterparty (which has to borrow money) and the CRA. Still sounds too good to me.

  37. Michel May 10, 2014 at 12:52 pm

    As an investor with a large cash position waiting to be deployed, a significant portion going in fixed income, I will continue to allocate toward BMO ZDB Discount bonds fund. For the record i use XSB/VSB for the fixed income in my registered accounts.

    HBB is the magic formula but i think it is simply too good to be true, i expect CRA to be all over this. There is no free lunch.

  38. Oldie May 10, 2014 at 5:40 pm

    @Michel: Is your (taxable) cash position “waiting to be deployed” or continuing to be allocated to BMO ZDB, or a bit of both? I am in a similar situation, and found it difficult to disentangle the eventual net tax treatment of returns from ZDB and BXF. I couldn’t get a verifiable answer, so, faced with the same choices that you outlined, ruled out the standard XBB/VAB/ZAG ETFs as too tax inefficient, decided not to go with GIC’s and arbitrarily chose BXF over ZDB. The fact that there was an MER holiday until July 2014 didn’t hurt, but really, I couldn’t figure out how much capital gain over the interest bearing portion each would yield. (Did you consider BXF, and if you did, what was your reasoning to prefer ZDB?)

    I did get the idea that any capital appreciation (for ZDB and BXF) that was returned to the ETF holder would unfortunately be treated fully as income rather than capital gain for tax purposes. However I was prepared, reluctantly, to pay the tax on the interest income, as long as it was not artificially increased because of underlying bonds being purchased at a premium.

    The appearance of HBB, if it lives up to its promise sounds like a perfect solution for my (our?) requirement. I understand your skepticism, but HXT and HXS have continued to be allowed by CRA, and as far as I can see, it’s essentially the same arrangement.

  39. Holger May 10, 2014 at 6:04 pm

    I suppose we need to wait until the 2014 T3s are out to get a clear picture of the tax treatment of ZDB/BXF distributions.

    I am in a similar situation inasmuch as I am forced to hold a significant part of my fixed asset portion in taxable accounts. So far I split that between ZDB and a 1 year Term Deposit with a Manitoban Credit Union.

    Given that HXT/HXS were acceptable to the CRA so far and with prior experience with swap-based ETFs in general I feel quite comfortable with shifting part of my holdings over to HBB.

  40. larry May 10, 2014 at 6:15 pm

    Duration too long for most accounts that pay taxes

    A 7 yr ladder would grab my attention

  41. Oldie May 10, 2014 at 8:34 pm

    @Holger: Glad to compare notes with yet another Couch Potato in the same situation. I assume you were just as flummoxed as I was to try and get a clear idea of the tax treatments of the ZDB/BXF distributions from what information was available from the companies and from tax experts in general. What made you opt for ZDB and not BXF? I was also seriously considering that same Manitoba Credit Union, only difference being that I had the idea that a 4 or 5 year rotating ladder would be the way to capture the highest interest and yet leave scope for annual rebalancing. However, I was nervous about never having done it before, and what to do if rebalancing was not symmetrical, as it was bound to become, and there were eventually widely differing amounts in each annual rung.

    In the end I hoped that BXF would give the least complicated method of providing a high expected average interest given the constraints, plus the availability of cashing in at reasonable variability of return in amounts necessary for periodic rebalancing.

    However with the latter solution, I’m still paying tax yearly on the interest portion of the income (and maybe on some capital gain equivalent which, unfortunately, it seems, will be taxed as income). I follow your opinions on HBB with interest. You seem to be knowledgable about swap based structures in Europe, and also personally with some swap based structured funds. I am comfortable enough with swaps that I hold HXS. I would also be very comfortable with HXT, but I need some income, and so I provide this with tax-friendly dividends from plain vanilla VCE, plus some holdings of FXM and Canadian Preferred Share ETFs. I may consider ditching the latter if HBB passes scrutiny — I’m not sure the tax friendliness and minimal further diversification is worth the 0.50% MERs.

  42. Holger May 11, 2014 at 12:57 am

    re BXF vs. ZDB: This is a preliminary choice based on the slightly higher YTM of ZDB. I plan to re-evaluate my decision in April 2015 when the 2014 fund T3s become available and/or in case the interest rate climate changes significantly. ZDB has 2.3 times the duration of BXF and, thus, takes more of a hit from an interest rate hike.

    I understand your reluctance regarding long-term GIC ladders. These are quite inflexible. With new products on the market every year and changing tax rules, 5 years are a long time. That’s why I do love these 2.45% (2.35% now) 12 month redeemable GICs. You cannot get a return like that with zero interest rate risk anywhere else.

  43. Oldie May 11, 2014 at 3:52 pm

    @Holger: “That’s why I do love these 2.45% (2.35% now) 12 month REDEEMABLE GICs” (my capitalisation). If I understand your point correctly, “zero interest rate risk” means the redeemable feature enables you to take a calculated loss (there must be a penalty for redeeming) and redeem if interest rates rise significantly so as not to be locked in and thus to lose on opportunity for higher current interest rates.

    I would think that HBB, if it lives up to its promise, and if CRA leaves it alone, would be an even better deal (net of taxation in a non-registered account, that is) in the long haul.

  44. KayT May 11, 2014 at 4:37 pm

    HBB only trading for two days and AUM at $14M, ZDB is $16M. Can one draw any conclusions about likely success or interest?

  45. Michel May 12, 2014 at 11:40 am

    @Oldie I already have some asset in ZDB and more cash to be deployed in the coming weeks. I did not considered BXF since it failed to attract significant assets, currently only 5M after almost a year since inception date! Here is a quick summary of the pro/con for each bonds ETF “category”:

    PRO: Short term bonds, less vulnerable to rising interest rate (Duration 2.8 – 2.9 years)
    PRO: Does not hold many premium bonds, since they are short terms
    CON: Not tax optimization

    CON: Medium duration bonds, vulnerable to rising interest rate (Duration 6.7 – 7.0 years)
    CON: Hold many premium bonds
    CON: Not tax optimization

    CON: Medium duration bonds, vulnerable to rising interest rate (Duration 8.7 years for ZDB but much lower for BHX)
    CON: BXH very low AUM, low volume on ZDB
    PRO: Tax optimization

    PRO: Tax optimization (No distribution!)
    CON: Vulnerable to CRA will

  46. Oldie May 12, 2014 at 2:38 pm

    @Michel: regarding low volume on ZDB and very low AUM on BXF, does this mean
    1) No one else thinks this is solid; what are they seeing that I am missing?
    2) When I trade in or out, the large volume of my trade relative to the existing volume distorts prices to my disadvantage?
    3) It suggest a higher risk of fund folding/ defaulting etc.?
    Or combination of all 3?

  47. Linda Rocco May 12, 2014 at 5:01 pm

    If I get it right, for someone who’s still in the accumulation phase, HBB like HXT and HXS turn your cash account into an RSP-like structure since you can defer taxation over time. And it’s possibly even better because all growth in an RSP is fully taxed (like interests) while your swap-based investments would be taxed as capital gains. Converting dividends into capital gains like HXT and HXS is one thing but the ability to indefinitely report taxation will be their downfall.

    Could they limit these products to registered accounts ?

  48. Be'en May 12, 2014 at 10:25 pm

    Similar offering for international equities should not be far behind :)

  49. Canadian Couch Potato May 12, 2014 at 10:34 pm

    @Linda: Swap-based ETFs allow you to defer taxes, but I think it’s very misleading to say they give non-registered accounts “an RSP-like structure” or to suggest they are “even better” than RRSPs. You can’t ignore the tax deduction you receive when you make an RRSP contribution in the first place. I think it’s also important to understand that swap-based products offer no benefit in a registered account, except perhaps the minor convenience of automatically reinvested distributions. Rather than being limited to registered accounts, they were specifically created for non-registered accounts.

    As general comment, I am still working on getting more information from Horizons about this product and will report back once I have anything interesting to share.

  50. Linda Rocco May 12, 2014 at 10:59 pm

    @CCP: Yes you’re correct. I forgot the initial deduction but it still offers the capability of deferring taxes on a product over which you couldn’t otherwise avoid annual taxation. I don’t know big these funds but as Dan Hallett expressed it before, they’re not fundamentally different from future-based investment products.

    I’m left puzzled as to how to quantify the associated regulatory risk.

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