Horizons has launched a new ETF in Canada providing tax-efficient exposure to emerging market equities.
The ETF uses a total return structure in a bid to enhance its tax efficiency.
The Horizons Emerging Markets Equity Index ETF (HXEM CN) has listed on the Toronto Stock Exchange and comes with a management fee of 0.25%.
It is linked to the Horizons Emerging Markets Futures Roll Index which represents the return on investment in futures contracts tracking the MSCI Emerging Markets Index.
The MSCI Emerging Markets Index, arguably the de-facto reference for emerging market equity performance, comprises large- and mid-cap stocks representing approximately 85% of the free-float market capitalization of 26 different developing country exposures.
China accounts for the bulk of the index with a weight of 41.1%, followed by Taiwan (13.0%), South Korea (11.5%), India (8.1%), and Brazil (5.4%). Chinese A-shares are currently included in the index at a 20% partial inclusion factor.
As for sector exposures, the index is currently tilted towards information technology (18.4%), financials (18.1%), consumer discretionary (18.0%), and communication services (13.0%), followed by materials (7.0%) and consumer staples (6.4%).
Steve Hawkins, President and CEO of Horizons ETFs, commented, “In emerging markets across the world, the effects of rapid economic development and globalization have resulted in a number of companies in developing regions becoming globally significant companies such as Tencent Holdings, Taiwan Semi-Conductor, and Samsung Electronics, to name a few.
“In our view, investors that ignore developing markets, ignore key companies that are likely going to play a more significant role in the global economy.”
Tax-efficient exposure
The ETF tracks its underlying index using synthetic (total return swap) replication. While the underlying stocks in the index may pay dividends, the ETF does not, and the value of any dividend payments in the index is capitalized in the fund’s net asset value. The ETF is thus not subject to foreign withholding tax since it does not actually receive physical dividends.
Dividends paid by foreign companies are also not eligible for the Canadian dividend tax credit and are taxed as regular income at the investor’s marginal tax rate which could be in excess of 50%. The ETF’s structure, however, means that accrued capitalized dividends will be taxed at the more favourable capital gains tax rate and only when the investor sells their stake in the fund.
“Our family of total return investment ETFs has been the fastest-growing product suite in our business with some of the best-selling ETFs in Canada in 2020,” said Hawkins. “The tax-efficiency of our corporate class structure offers investors an opportunity to participate in the rise of emerging markets without being subject to taxes on dividends and foreign withholding tax which can erode total return and require investors to navigate and assess complex tax scenarios.”
The fund’s management fee (0.25%) also matches the cost of the two existing MSCI Emerging Markets ETFs available in Canada – the $1.8bn BMO MSCI Emerging Markets Index ETF (ZEM CN) and the $730m iShares Core MSCI Emerging Markets Index ETF (XEC CN).
Investors can gain slightly cheaper emerging markets exposure through the $1.0bn Vanguard FTSE Emerging Markets All Cap Index ETF (VEE CN) which costs 0.23%. This fund is linked to the FTSE Emerging Markets All Cap China A Inclusion Index which has some subtle difference to the MSCI index: it excludes South Korean stocks (FTSE Russell classifies South Korea as a developed market) and also additionally includes small-cap stocks.