Horizons' Corporate Class Structure Is Not Tax Efficient

One resource that I check out every year is MoneySense’s “Best ETFs in Canada” guide.

They bring on a panel of experts to find Canada’s top ETFs for DIY index investors (like myself). I found this guide extremely helpful when I was first getting started in investing, and now, many years later, I still read it when it gets updated annually, just to be “in the know” of what’s happening when it comes to index investing in Canada, and to stay up to date on any significant changes like the updated fees, new ETF offerings, and any changes to existing top ETFs that you and I have in our portfolios already.

This podcast interview is different from you just reading the written version of the guide because we actually do a deep dive into the different ETFs that are in the guide. 

Definitely check out the written version of the guide as well, especially since it has some really useful tables that nicely summarize what the top ETFs are, in the different categories. But, definitely still listen to this interview as the writer of the MoneySense guide is on the show today to dive deeper into the findings, along with one of the top panellists and experts, Ben Felix from PWL Capital to provide his analysis on the different top ETFs.

Questions Covered:

1. Bryan, can you start by telling us about your background, as well as this annual initiative led by MoneySense to determine the best ETFs in Canada? Ben, can you tell us a bit about your background and the work that you do?
2. Bryan, how does voting work among the panellists before an ETF is admitted as one of the “Top ETFs in Canada”?
3. Bryan, there are a lot of different investing strategies out there. When you and the panellists are evaluating what the best ETFs in Canada are, what is the goal and strategy that you are all focused on and what kind of investor is this top ETFs list for?
4. Ben, before we get into the results, what should someone do if they are holding a past ‘top pick’, and now they no longer see that pick on this year’s list? In other words, when should we actually really consider swapping to a completely different ETF if we already have a good diversified index portfolio in place?
5. Ben, when it comes to switching from one ETF to another, what are the trading costs that we need to be aware of? The $5-$10 trading commissions are the one I think most people are familiar with, but what about the bid/ask spread, how much of a cost impact does that have? And are there any other costs we need to be aware of, when for example someone is tempted to switch ETFs because let’s say, a top pick for this year has a slightly lower MER?

Top Canadian ETFs:

1. Alright, let’s take a look at the top Canadian, total market, index ETFs that give you exposure to the Canadian stock market. I noticed that all three of the top picks have the same management fee. We have BMO with ZCN, Vanguard with VCN, and iShares with XIC. Ben, BMO’s ZCN and iShares’ XIC look almost identical to me. Are there any key differences between these two that we should be aware of?
2. The other thing that jumped out at me is that Vanguard’s VCN has fewer holdings, 181 vs 240 compared to the iShares and BMO ETFs. Would this be considered a concern by implying that the Vanguard ETF is less diversified than the BMO and iShares versions? i.e. Why would you go with Vanguard when you can get more holdings and be more diversified with XIC or ZCN?
3. Bryan, another top pick in this category is Horizons’ HXT ETF, which covers the S&P/TSX 60. You mention in the article that “it’s tax-efficient; and has a rock-bottom 0.04% fee after the rebate, until at least Dec. 31, 2022”. Can you explain what this rebate is, and why the “at least Dec 31 2022” timeline?
4. Ben, Horizons has this unique tax structure with some of their ETFs, like HXT, where you don’t receive the dividend payouts as income, but instead they get added to the fund so that you instead receive more capital gains. I realize that I’m maybe oversimplifying things a bit here, but essentially by holding an ETF like HXT in a personal taxable or corporate trading account, some Canadians save money by reducing their clawbacks when it comes to things like CPP, OAS, the Canada Child Benefit (CCB), and avoid the high tax rate when investing in a corporate account.Now in the past, the government closed this, (what I would consider a) loophole, but Horizons figured out a way to restructure their ETFs so that Canadians can still get these tax savings.This raises the concern of: What if the government changed things again, closes the 2nd loophole, and Canadians that were holding Horizons ETFs like HXT start selling off ETFs like HXT in large quantities because it no longer has this tax advantage? In this scenario, would the ETF plummet in price? Or no, because the ETF is still holding companies (in a way), and it’s not like the value of all those companies will drop because there is a massive sell-off of the Horizons ETFs.
5. The last time this closing of the “loophole” happened where the government changed the rules, I recall Horizons doing a press release where they said that if they can’t find a workaround, they may have to close down those ETFs. If that was to happen in the future, would Canadian investors be hurt by this?
6. Bryan and Ben: The other concern with HXT, is that it is only 60 Canadian companies, and I think most Canadians (myself included) would rather go for the total market approach with an ETF like ZCN, where they are now getting the entire S&P/TSX index with its 240 stock holdings.Do you think this tradeoff is worth it? (where you’re getting less diversification, but some potential tax savings and/or clawback reduction on government benefits).
7. Bryan and Ben, most Canadians do have a home country bias when it comes to their investment portfolio. Even when we look at asset allocation ETFs from all the major providers, they definitely hold more of Canada than Canada’s percentage of the world equity markets. Why is that, and what is your stance on what percentage Canadian stocks should make up of a Canadian DIY investor’s investment portfolio?

US Market ETFs:

1. Alright, let’s jump to the US market. XUU still appears to be the favourite here among the panelists, as far as Canadian listed, US total market index ETFs go. The runner-up seems to be VUN which is comparable in terms of US stock market representation, but has a higher fee of 0.15% vs XUU’s extremely low fee of 0.07%.Do you guys have any thoughts and comments on this one?

International ETFs:

1. Alright, let’s jump to international stocks. Can you give us your thoughts on these, while touching on some of the nuances when it comes to choosing the different combinations, from the different providers, when it comes to emerging and developed international markets?