Horizons ETFs Management (Canada) has launched the Horizons Cdn Select Universe Bond ETF (HBB), which will provide investors with low-cost and tax-efficient exposure to the Canadian investment grade bond universe.
HBB, which is now trading on the Toronto Stock Exchange (TSX), seeks to replicate the performance of the Solactive Canadian Select Universe Bond Index, net of expenses.
HBB will also be the first fixed income exchange-traded fund (ETF) in Canada to use the total return swap (TRS) structure employed by Horizons ETFs’ popular suite of low-cost TRS equity ETFs which includes the Horizons S&P/TSX 60 Index ETF (HXT) and the Horizons S&P 500 Index ETF (HXS). This total return structure can reduce the risk of tracking error for ETFs that arises when seeking to replicate their referenced indices while also providing tax efficiency for unitholders.
“The Canadian index ETF market may be viewed as saturated, but that doesn’t mean there isn’t room for further product innovation,” says Howard Atkinson, president of Horizons ETFs. “HBB is an example of how indexing in the fixed income space can be made better by both improving the underlying index and utilising a TRS structure to reduce the potential for tracking error and improve tax efficiency.”
The Solactive Canadian Select Universe Bond Index was developed and is calculated by index provider Solactive, which has approximately USD20 billion invested in products linked to its indices with 125 ETFs benchmarked to them.
There are more than 1,300 bonds in the Canadian investment grade bond universe, many of which do not have sufficient liquidity to be used efficiently by an ETF in replication. As a result, most bond index tracking ETFs in Canada engage in a practice called “stratified sampling,” whereby they hold a smaller number of bonds than the number of bonds that are in the index they are seeking to replicate. This sampling, in addition to other factors, can contribute to a higher risk of performance tracking error with bond index replication strategies.
Recognising that sampling is a reality of bond indexing, the Index seeks to reduce replication costs by having fewer constituents. Currently, the Index only holds 180 liquid bonds and offers similar duration, yield and return characteristics to the broader Canadian investment grade bond universe.
“We’re very happy to be partnering with Solactive on this ETF. We think they have done a great job in building a fixed income index that offers all the performance characteristics of the broad Canadian bond universe, but uses a more focused methodology that allows for easier and cost-efficient replication,” says Atkinson.
Similar to the other total return swap ETFs that Horizons ETFs offers, HBB will track a total return version of the Index, which means that the net-asset-value of the ETF will immediately reflect the value of any distributions made by the underlying securities of the Index.
“Over the last three and half years of running TRS-based ETFs, they have not had a single taxable distribution and we expect the same for HBB,” Atkinson says. “Fixed income investors may find the idea of a bond ETF that doesn’t pay distributions a little different, but we believe by eliminating regular taxable distributions HBB is strategically positioned to deliver better after-tax total-return performance than all the other Canadian bond universe index ETFs.”