Horizons ETFs introduces Canada’s first swap-based bond index ETF

May 13th, 2014 | By | Category: Fixed Income

Horizons ETFs, a Toronto-based provider of exchange-traded funds, has introduced Canada’s first swap-based bond index ETF: the Horizons CDN Select Universe Bond ETF (HBB).

Horizons ETFs introduces Canada's first swap-based bond index ETF

Howard Atkinson, President of Horizons ETFs.

Listed on the Toronto Stock Exchange, the fund will provide investors with low-cost and tax-efficient exposure to the Canadian investment grade bond universe.

The fund is linked to the newly launched Solactive Canadian Select Universe Bond Index, an index developed and calculated by Solactive, one of the world’s fastest growing index providers in the ETF space.

The index is designed to measure the performance of the Canadian investment grade bond market (government and corporate bonds) by selecting a representative group of bonds. 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 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.

Recognizing that sampling is a reality of bond indexing, the index seeks to reduce replication costs by having fewer constituents. Currently, the index holds only 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” said Howard Atkinson, President of Horizons ETFs.

Another distinctive feature of the ETF is its construction. In contrast to the vast majority of Canadian ETFs, the fund employs a total return swap (TRS) structure to replicate the performance of the index. Swap-based structures tend to reduce the risk of tracking error for ETFs that arises when seeking to replicate their referenced indices while also providing tax efficiency for unit holders.

“The Canadian index ETF market may be viewed as saturated, but that doesn’t mean there isn’t room for further product innovation,” said Mr Atkinson. “HBB is an example of how indexing in the fixed income space can be made better by both improving the underlying index and utilizing a TRS structure to reduce the potential for tracking error and improve tax efficiency.”

The fund has a management of 0.15%.

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