On today’s episode, we are joined by Jaime Purvis, Executive Vice President at Horizons ETFs. Having been the company’s third ever employee, he has worked at the company for nearly 24 years and provides an in-depth inside look into how Horizons has come to have the reputation of being ahead of the curve in the Canadian ETF market. He takes us through some of Horizons history, how they got into ETFs, as well as giving some insights into how these products were chosen. Given the instability of the market today, it is important not only to innovate, but also to leverage experience when creating ETFs, which is what Horizons seeks to do. With such high levels of unpredictability, they aim to provide their clients with as much knowledge as they can to make informed decisions, especially given the Canadian national budget proposal, which will likely affect ETFs across the board greatly. Along with this, Horizons has also created a variety of ETFs, based on products they anticipate will soon play a huge role in daily lives, such as robotics and AI. Despite casting this wide net, these decisions are still made with careful consideration, drawing on the company’s extensive knowledge pool. This ability to continually innovate has put them at the forefront of the Canadian ETF market. To gain more insight into the world of ETFs and Horizons, join us today!

Key Points From This Episode:

• How Horizons has swap structure works and why these swaps should not be feared. [0:06:55.0]

• What the rationale behind the Canadian government swap-based ETF targeting is. [0:11:45.0]

• What the redeemer’s methodology is and the effect that is has. [0:16:08.0]

• What some of the risks associated with the swap-based ETF structure are. [0:23:56.0]

• The situations where it does not make sense to have a swap-based ETF. [0:28:43.0]

• How Horizons chooses their thematic ETFs. [0:30:35.0]

• What the deciding factors in closing a stock down are. [0:36:29.0]

• Why it is becoming increasingly difficult for starter ETFs to launch. [0:39:20.0]

Read the Transcript: 

Jaime, you’re with Horizons who I’m sure a lot of our listeners are aware of, but can you tell us a little bit about Horizons?

Yeah, Happily. I’m nearing 24 years with Horizons. I started my career there in Vancouver when it’s a retail based alternative shop. I was the third employee, the first one not named Fred, we had 17 million dollars in the AUM. About 13 years ago, we made a bit of a strategic pivot when one of our then fund managers that Adam Felesky came to us with the idea of being the pro funds or pro shares of the north and so we looked at it and valued it as a business opportunity and launched our first leveraged bull and bear plus mutual funds.

And a year and four months after we launched those mutual funds, we rolled them into ETF’s we were able to do that and thus began our ETF journey. We now manage 11 billion dollars, almost in ETF’s. Of that only less than one billion is in the leverage product that we originally started with. 2009, two years after starting that, we sort of realized ETF’s are just a super-efficient delivery vehicle.

And decided that we would be well off to concurrently launch to business lines, one that was passive, more traditional, goal-oriented ETF’s and then also a lineup of actively managed ETF’s. This time, our assets, the remaining 10 billion are split almost 50/50 between active and passive. That’s been that and six years ago I think we sold to Korean asset manufacturer so, while we are a made in Canada story, and a Canadian operation, we are 100% owned by a Korean firm called Mirae Asset Global Investments. 

It’s a success story, the chairman there is a fascinating guy, launched his business 20 years ago and he still owns the company 100%, they manage 140 billion dollars.

When you think about Horizons, in the context of the Canadian ETF landscape, we have iShares and Vanguard battling for the lowest cost, total market ETF’s, how do you think Horizons fits in to that?

Well, going back to our very beginning, we’re innovators. The BetaPro ETFs were the first of their kind in Canada, they’re still the only ones. But they’re a very different kind of ETF than what had opted that point had been traditional ETF’s. 

So, we innovated in that sense. And then when we launched the active ETF’s, they’re the first truly active ETF’s in Canada. When we say active, we mean, looking to some degree, but not really like a mutual fund. Where you have a portfolio manager, who has a personality or style or what have you, that lends them to a field of expertise in a certain segment of the market.

Our positioning in the active is the first real true active management in Canada now, pretty much everyone’s got active. In fact, we’re hearing that Vanguard, the traditional, everyone thinks that Vanguard is a passive shop, but that’s what they’re known for their ETF’s. But in truth, they’re a monstrous active and passive shop. when Vanguard are talking about doing some active work in Canada, say okay. I think everyone’s jumped on board.

BMO have active, pretty much everyone has active, we were the first we think to be really truly active and our business line reflects that. We’ve been active in places where we think indexing is inefficient. Fixed income would be one space, dividends, we’re not active in the broad, large capped Canadian equity because it’s really hard to create value there, we think. We’ve innovated with the BetaPro, we innovated with the active, with our passive lineup, our total return index ETF’s.

We innovated as well because when we looked to enter that market. We said, “how do we compete with the iShares of the world?” At that time, it was just iShares in Canada, Vanguard hadn’t come yet, but with the big boys. And we said, “can we just compete on fees? How much assets are we going to be able to move by being 10 basis points cheaper if people say we only know Horizons is a leveraged ETF shop, not an indexing shop.”

So, when consultation with our banking partners, we came out using the TRI structure which essentially invest in a total return index, meaning, the dividends accrue to the Nav, to the value of the index rather than being paid out. And we use a total return swap to get that. Swap’s a word that scares people and we’ve taken long educational process to explain to people what those are. 

But the structure that we’re using is essentially that was used, is still used, but not nearly as much right now by Canada’s major public pension plans. If you’re teachers or owners, CPP or the case, you don’t want to be managing that stock portfolio, you want to call the bank and say, “hey, we’ll give you two basis points to give us the return to the TSX 60.”

Can we back up on this for a second? Can you dig into exactly maybe walk us through how the swap is structure works for the ETF unit holder?

But yeah, I mean, the structure essentially – well, not essentially, this is what happens. Like any mutual fund or ETF, the assets, the client go to the custodian, they sit in the custodian. Then you can buy the shares and shares sits with the custodian. In our case, all the cash sits with the custodian, so CIBC would be our lead there, NBIN as well.

What we do is that cash earn CDOR, which is the rate at which the banks will lend money to each other. It’s currently about 2.2%. We enter into a total return swap with our counter parties, which are currently natural bank and/or CIBC depending on the ETF. The swap part of the transaction is that we’re swapping them, that returns on the cash, on the client’s cash. So, 2.2% right now, the counterparty holds the stocks that make up the TSX 60 or whatever the underlying is, on our behalf.

They’re responsible for managing that, the nice thing about a swap is if they were to mess that up, which the banks are not in the business of messing that up. but if they were to, it doesn’t matter. The line I always use in retail land is – I mean, we care, but we don’t really care what they own on the other side of the swap, it could be a giant bag of cookies. 

They still have to deliver to us exactly the returns of that total return index, less fees. So, what we’ve done in creating this structure, which will get to tax efficiently but we also competed on price. So, when we launched the TSX60, we came out at seven basis points, the main competitor there is XIU, the oldest ETF in the world and what I used to call Canada’s best ETF. I think we’re better, but that’s a little bias. 

They were at 15. When you count at the HXT, they’re 18 basis points, we were eight and change. That was enough to move the needle. So, we instituted a fee rebate down to five after a year and then another year in, we’re down to three.

So, the cost of our ETF for you to own the TSX60 is 3.45 basis points, versus 18 for XIU. 15 basis points, that starts to add up. Anyone can do the math on that, every year that goes by, that’s more savings in your pocket and that increases. And, in this kid of rate environment, every penny that you keep is really useful to you.

So, our structure there is that the counter party owns the stocks for us and delivers returns.

Can you talk a little bit about – HXT was the one that you were just talking about as a comparison to XIC. Can you talk a little bit about how HXTT does not have a swap fee? But some of the other ones do, can you just talk about the difference that’s going on there?

Yeah, so in simplest terms, a Canadian bank gets treated differently on dividends, on Canadian equities that they own than a retail client would, retail investor. They have whether we call it a tax arb or different tax treatment. They’re able to pass along the benefit, some of the benefit that they make on that difference to us in the form of zero cost swap.

As well, because they’re Canadian, there’s no withholding for them to manage off. So, that gets eliminated. If you look at our international, you can see that our swap fees are clearly mitigating that withholding fees.

Yeah, that makes a lot of sense. Can you talk a little bit about, you mentioned tax efficiency so can you just talk a little bit about why the structure can make a lot of sense for people who are taxed at a higher rate?

Well sure. I just shouldn’t say we’re all taxed at a higher rate. But those among the listener’s fortunate enough to be taxed at a high rate understands that that rate keeps getting higher.

Right. I guess when we talk about saving every penny that you can, that’s why people invest in TFSA’s. That’s why they use registered plans, it’s why there’s any number of instances, you know, that you’ve seen in the past, you’ve seen flow throughs and all sorts of deals that are designed to save some tax for investing in Canada.

So, that’s our structure designed to allow you to defer paying tax because you don’t get the dividend flow to your portfolio every year, which what most your clients do when they get dividends.

Reinvest. And then at year end, they pay taxes.

This structure is akin to a registered plan in terms of what it looks like from a client’s tax perspective. At the end, they’re going to pay their taxes on a larger share, but not pay a year after year. The longer you hold, the better the benefit is, but at the end of the day, they government’s still getting their taxes, which they’re keen on collecting.

So, one of the things that’s happened recently which makes this conversation very timely is that the federal budget seems to have addressed or targeted the swap-based ETF total return structure. Can you just talk a little bit about how Horizons is looking at the potential impact of these? 

Yeah, let me give a little history on how they do this and we’ve often said to their credit and was finance minister Flaherty, who had this happen twice on his watch. We think back when we called the Halloween Massacre, the year when we had the income trusts, which was the policy for the income trust was created to allow oil and gas and mining companies to give some sort of tax deduction for the money they were spending on trying to extricate resources, which added huge benefit to Canada, to the economy. 

What happened was, we had all sorts of other companies, start becoming income trust and the big one became, when BCE said hey, we may convert to an income trust and that’s when he blew the whistle and said, “all right everybody out of the pool. This is done. Right?”

That had happened and then if we look back to 2013, what had happened. Ben, you’re much younger than I am, I don’t know if you recall Cam’s not here, but he would recall this as well. In the old days, our registered plans had foreign content limits, we can only hold up to 20% of your portfolio in non-Canadian. But that doesn’t do anyone very well, in a country that’s already got a huge amount of home bias in this investing, I think this is a fundamental tenet of your practice.

Well, that doesn’t do us any good. What the fund companies or banks and independents alike created were these sort of synthetic structures to allow you to hold 90% of your fund holdings were in Canadian cash and the other 10 cents on the dollar was used to fund a margin account to buy futures, that bought the SMP500, the NASDAQ or whatever you wanted to have. You can get your full hundred percent exposure, but your portfolio is still with 90% cash.

So, that structure was used and because they were investing in foreign indexes, the CRA essentially allowed that o be taxed as equities, rather as an income. Which anytime you hold futures, you view it as a professional trader and does all your taxation income. There’s a loop hole created there to allow Canadians to get more foreign investment.

What happened as always, has happened in the financial industry is that companies twig on to this and started saying well, “we’ll have a big holding cash and we’ll buy bond futures.”

So, we’ll get bond returns and characterize that as I beg your pardon, capital gains.

This was 30-billion-dollar business I want to say. Back in 2013, there’s one ETF company, at the time was Claymore was doing this and then all the big mutual fund companies. I think the Mackenzie’s of independent or other, we’re using this to essentially re-characterize without there being any instrument for the CRA to get their pound to flesh taxes earned.

Flaherty looked at this and said, “okay, 2013,” blew the whistle again, told everyone to get out of the pool and said, what we’ll do is we’ll grandfather your existing forwards, this was called the 39.4 in the industry parliament forwards. And those forwards were, you were writing five year forwards.

So, let’s say the portfolio was 20% five years from now, 20% four years from now, they just let those expire. In 2018, the last of those expired. They didn’t do anything punitive, but they just said, we’re not going to be doing this anymore because we’re not seeing the benefits of this as a taxing entity. 

The next thing when you look at what is proposed here and it’s really important to note that this is proposed and our structure will – the total return index structure, the total return swap, is fine for 2019. If enacted as proposed, we won’t be able to run our structure the same way going forward.

That said, this is a very preliminary proposal, it’s the proposal, but like we’ve seen in any budget put forward by this government or others, there’s a series of other effects that happen and there’s negotiations and say “hey, we’re targeting this but what’s our spill on effect on other things.”

“How are we going to implement this?” As it stands, our ETF retain their tax efficiency through 2019. What happens beyond then, I mean, I can’t speculate, we don’t know where this is going to go.

If we just took a hypothetical and just said that the budget passes as written for this specific portion. What does that look like? Like not understanding how the structure works currently to be tax efficient, where does that tax efficiency stop if the budget goes through as proposed?

What they’ve targeted in this budget and what’s called the redeemer’s methodology. Without getting into the arcane details of this budget and what happens there, the redeemer’s methodology is something that exists in Canada and the US, essentially allows the market maker.

So, when you sell a unit of an ETF, you’re not actually a redeemer. It’s like a stock, you’re just trading, it doesn’t disappear. When you sell a unit of your mutual fund, it disappears. I always described as this, it’s like buying a ball. When I go to a mutual fund, I buy my ball, my mutual fund, they create that ball for me, I use it and when I’m done with it, I sell it back to them and they destroy it. 

With an ETF, you get a store that buys a bunch of balls from the factory. We’re the factory, the store is – we’ll say the store is National Bank Financial. They buy a bunch of these balls and then they sell them the marketplace, to the other users. The other users can then sell those balls back and forth and back to National Bank or the other banks that run market making desks. So, that ball can be used many times by many, many, many times by many different investors, but when the market maker, anyone of the market makers, which all the Canadian banks essentially have market making operations.

When they decide they’ve got too much inventory and keep in mind, when they have that inventory, they’re paying fees. There’s fees there. They say, “we don’t want to own his anymore, we’ll sell it back to the factory.” That’s us. That’s when that ball gets destroyed. Anytime there’s that ball gets destroyed, the mutual fund or ETF land, that’s when the tax ramifications, when they sell the ball back to us, we say “okay, well, here’s the part of the swap portfolio that we’re giving back to you.”

“You have to tell the government what your tax liability is on that. We’re assigning it to you as income because they’re a pro trader going back to what we were talking about futures earlier.” Everything they do is professional, so it’s viewed as income. How that gets taxed seems to be the issue.

So, it’s not in the ETF structure, it’s at the redeemer’s level which is the market makers and the governments both in Canada and in the US have allowed the two iterations of the redeemer’s methodology to exist, to allow facilitation of the buying and selling of shares in a tax efficient manner. Because what you’re doing is trying that example I’ve read lately is in the states.

If your redeeming units of an ETF that owns a ton of Facebook and has forever, what they’re giving back to you are the stocks.

The Facebook stocks. Well, those Facebook stocks have appreciated significantly, so they allow them to write that of so that all the transaction in Facebook doesn’t affect the cost.

So, the market maker is able to hold it and use it again.

This wouldn’t just effect swap-based ETF’s, it would be pretty sweeping.

Yeah, it’s certainly well, it looks to be targeted at swap-based ETF’s, the reality is that this redeemer’s methodology’s used by all ETF’s and by mutual funds, in Canada. So, that’s what I was referring to earlier when I say that you’re potentially targeting A, swap-based ETF’s because they’re not getting their pound of flesh from their redeemer’s as I’d like.

But it’s effecting all the other ETF’s because what this essentially mean is that we, as ETF providers would need to know every individual’s holdings in ETF’s, that’s one of the reasons ETF’s are so cheap is because we don’t know who our clients are.

You tell us, you might tell us how much you hold our ETF’s but we don’t know who all the individual clients are.

And so we’d need to know that to calculate their adjusted cost basis to then issue them, essentially T4s, whatever their appropriate tax forms would be. But it doesn’t allow for the differentiation of what the type of account is. 

So, there’s all sorts of complications as well, if you’re issuing that at year end, what happens for investor A who owns the ETF from January to November and sells? And investor B who owns and buy the ETF in October and owns it at year end? It would seem that investor B is assuming the tax liability of investor A because they got out before year end. This is a historical issue to some degree in mutual fund land. 

You got residual tax issuance, that’s, the guys left holding the bag at the end of the year. There are it would appear, you know, upon talking to many other industry participants, there’s some inefficiencies in the budget, as proposed. What happens with it? I can’t speculate, but we’ve seen historically, this government and previous governments, issue a proposed budget and t hen figure out what’s actually rational and walk it back a couple of steps to say, “how do we do what’s best for Canadians, target what we think is this issue without affecting other Canadian’s adversity or affecting the Canadian market place?” Because this government’s very keen on protecting the middle class and growing the middle class.

The middle class is exactly who is saying, “yeah, we’ll buy ETF’s because they’re cost efficient.”

So, there’s still work to be done, what this market looks like in January of 2020, I don’t know.

So, you guys must be getting a ton of questions, what are you telling your clients about this?

Well, our positioning for the client is all that we know right now is that this proposed budget, if enacted, as proposed means that our TRI ETFs lose their tax efficiency in 2020 and beyond.

How the budget ends up looking is the difference. What does that mean for us as an ETF company?  Well, if the structure doesn’t work, do we close ETF’s? Do we restructure them? I think you and I could have a conversation where we come up with many alternatives. I think it’s safe to say that we’re working on a variety of alternatives, the simplest one that people think of is what if you just went to be a physical ETF and compete on cost?

Which keeping in mind on our Canadian ETF, we’re already cost competitive. Talked about HXT being three basis points, 3.45 versus 18. But if you look at energy and financials, we’re on MER, not management fees of 29 basis points versus 61, versus Azure.

We recently launched three ETFs, I mean. Recently I mean, in Q1, six weeks before this budget came out on equal weight banks. Preferred shares and Canadian REITs all of those are priced about 10 points cheaper than their competitors at another dealer that use the exact same indexes.

Do your cost go up though if you can’t implement the same way?

Well, all of our costs will go up. All ETF company cost will go up. Yeah, it’s a matter of do we go even, you never supposed to call your own products cheap, more cost efficient? Whatever we want to look at it, that’s just one possible solution. Is there another structure out there? What if the CRA come back and say our budget allows you to run TRI for equities, but not for fixed income?

There’s so many different variables that we could be working on 20 different solutions right now. What we’re telling our clients is, “this is what we know is that of 2019, everything is status quo. 2020 if enacted, we will not be able to run the structure anymore. We’ll know a lot more in September.”

We’ll know more before September. The vote to ratify this or to enact, I beg your pardon is in September, typically. So, we’ll know before then and we are being very proactive in telling our clients, educating them. I mean press release the day after this budget came out. We think we have a fiduciary, ethical and moral responsibility to keep our clients informed and we will be doing the same thing as the future options. It is an unknown. 

What we are suggesting for our clients and what has been almost universal uptake has been no one has enough information yet. So, we want you, you want yourself to make an informed decision, make the informed decision when you have the appropriate information and we will be sharing that with you.

So, we just gone down the path of talking about the recent, the budget, which I would classify in terms of the risks specific to you to swap based structure as legislated risk. Now other than that, if we compare just a regular long on the ETF to the swap-based structure, what are some of the other risks that people should be aware of specific to the structure?

Well the other risk and the one that we have dealt with primarily for years before we ended up talking about regulatory risk was the counter party risk. So, Ben you are old enough to remember Nortel? You are in Ottawa, you got to have a Nortel experience. Well there was a Nortel effect. You remember Nortel became 44% of the TSX. So, they instituted rules off that that capped your exposure to any one issuance at 10%. 

So, keep in mind that I think we talked about this, what ETFs are legally mutual funds. We have fallen actually from 81 to 102. We just trade differently essentially. So, what that means is for that swap, we talked about that basketball, where we hold the client’s $100 and we enter into the swap and we pay away CDOR and they get the swap. Our exposure to the counter party is however much the ETF has gone up. So, you can only have 10% exposure to any asset besides cash. 

So, if we had a $100 or a $1 million in this I’d say in the TSX 60 and it went up 10% and our swap party was National Bank, we would then be at 10% exposure. So, all the gains would be exposed to National Bank that is assuming that there is no further subscriptions, right? Because any other subscriptions would bring that number down because we took another $100 million and also we’d be 5% exposed market to market. So that is one. 

Anyways, once that happens we have 45 days to rectify the situation and that can mean that the market drops, which means that all of a sudden we’re down 10%. Below 10% exposure to the counter party. Or we get another subscription. So, our asset base grows, but the total gain is we made $10 million, but now we’ve got $200 million so that is only 5% of mark to market exposure or we get redemption. So this is what’s really been key in the TRI structure because when we get a redemption, we are able to pick which swaps in our basket. 

So, we don’t just have one swap exposure, we have a basket of swaps and let’s say the markets just gone straight up for that 10%. We would be taking the original swaps that we wrote because they have the highest market to market exposure and redeeming those to the counter party, to National Bank. The counter party then would treat those gains as income and they would redeem them. So, what that means is that we have removed a section of the swaps with the highest marked market. 

Of course then that naturally brings down our mark to market exposure to the counter party. So, for example, the TSX 60, which we launched HXT, we launched on the September 15th 2010. Since then the TSX 60 is up about 63%. Our current counter party exposure is 1.5%. So, by virtue of the ETF growing and there had been continuous redemptions, we have been able to whittle down or I wouldn’t say whittle down, but to keep the marked market exposure low. 

So we’re not at the 10% exposure even though the ETF is actually up 60 plus percent so we’re not there but the risk is still let us say that we are 10% exposed to National Bank and before we could deal with it before we took any other subscriptions, our risk at National Bank goes under. So, you have to ask yourself what is the situation where the market is up and one of the major Canadian banks is going under or both of them?  Because keep in mind – 

Sorry, here is another method that we can deal with that mark market exposure, we add counter parties. We add CIBC. So, let’s say National Bank is at 10%, we add CIBC, they take on 5% of that you’ve got additional. So now you got to buffer them both. So, you are looking at a situation where you’ve got one counter party like here’s the worst case scenario. You’ve got one counter party, the market goes up 10%, you don’t have any subscriptions for redemptions in the interim and then they go under while the market it up. 

It is not impossible but you have to say, “what is the probability of this being a realistic risk assessment?” And I think that you can look at our track record of where the counter party exposure sits. We have ETF’s that made money over time, where the index is up and the counter party exposure is negative. That is the important part of what we do in this process of keeping down that counter party risk. 

We thought dealing with the regulatory risk as well because when you are signing way all that mark to market exposure, those positive gains, that is taxable to the CRA. That bit is where the redeemer’s methodology is being looked at right now. So, it is a very complex sort of operational things about an ETF, but this is really where the value has been provided historically.

It is really interesting. If we make the assumption that the structure is going to continue being taxed as it is now. So, say no legislative changes, do you think that there are any situations where the swap base structure does not make sense? Like I am thinking about the international and US swap ETF’s do have a swap fee in addition to the MER. Are there any cases where it doesn’t make sense to be paying that additional cost?

Yeah, typically in registered plans that would be the big one and this is true for all ETF’s really where you are making regular contributions. This is where the efficiency of mutual funds is that really your cost of transacting mutual funds is buried within the mutual fund value itself, whereas your cost of transaction ETF’s is on top of. If you think about what Canadians don’t like, they don’t like paying additional fees. 

That is why you think about DFC mutual funds being so popular for years. We now know that they are really not beneficial plans. Bur think about the GST or now the HST, right? It replaced a manufacturer’s tax years ago and I have some of this ridiculous knowledge, my father is an economist and I actually used to sit in the quiet room for the budget so that he would read the budget and write about it. So, when it came out is he is writing one of these reports. 

That is one of the things that I learned from his is that the manufacturer’s tax was higher than the GST. But by removing it by being a hidden tax and cost can be an added tax Canadians went crazy. That is part of the Canadian psyche and part of it is probably because retail said that, “We are not going to drop to price. So, we are going to add a couple percent of the profit line, right?” There is always operational issues but Canadians are oppose to paying additional fees. 

But that is one of the places, smaller accounts with reoccurring investments and registered plans are really the two where the tax efficient structure doesn’t make sense.

Yeah, investing outside of registered plans and a low income, I agree. Unlikely. So, one of the other things that Horizons has done quite a lot of other than the total return is doing some fanatic ETF’s like I know HMMJ has definitely been a big one with the whole cannabis craze that has been happening. How do you guys think about which thematic ETF’s you should create?

Yeah, well and I don’t have any samples of HMMJ just in case you are asking out there. That’s not why we are in the business although the first physical dispensary opened today, very exciting. I do think there is some humor to be found as well as the Ontario Cannabis Stars. OCS is not so much different from the OSC. It’s just flipping it around. But it is certainly thematically and I think we would admit to being very lucky. 

And capturing some lightning in a bottle with our marijuana ETF and certainly you are on record saying this in the beginning as, “look this as not a hugely liquid market.” It is probably the ugliest ETF we’ve ever launched when we launched it two years ago this Thursday there were 13 names in the units. One of them is Scott’s Miracle Grow, which allocates five to 10% of their business to medical marijuana to growing it, but it is a huge factor for liquidity. 

And now the most recent rebalance earlier this month we’re I think 59 names so it speaks to the growth of that industry that this has happened and the Canadian appetite for it. And that Canada being the ideal place for it to be distributed, if you look at a lot of the constituents are companies with operations in Columbia or in the US or Australia, but they list in Canada because the Canadian markets are favorable to listing. 

But we launched that two years ago. And it has been over and below a $1 billion for the better part of the year now. We had an in-house office pool, that’s where we thought it would be at your end and I think that the first year we are out and I came second, I think I said $220 million. I think the winner said 300 something and it end up being 860 at the first year. So, we certainly caught lighting in a bottle. I wouldn’t say that we weren’t thoughtful about it, but we were early and this is part of our history of innovations. 

That we are willing to take a little bit of risk here and kudos to our CEO, Steve Hawkins on this. He has become a real champion of marijuana businesses in Canada, but not just in Canada but abroad. I mean it is in Bloomberg last week, we’re in the Economist, things like that. That is not what we are planning, but we did see that we thought marijuana even just from a medical perspective had long term mainstream usage and you know I did some investor seminars the day before it actually launched. 

I was doing a bunch of 70 plus septuagenarians and they asked me about the product. I wasn’t there to talk about it, but they asked me and I explained it and there was one forgive the term, little lady who was tsk-tsk-tsk. All the other guys were like, “oh my wife uses a topical cream for arthritis and my buddy uses it to ease the pain of his cancer and I take the pills for my cataract surgery.” So, there was this huge underground swelling of favorable thought on medical marijuana that we hadn’t really tapped into. 

We thought we didn’t think it was that big. And then of course when the legalization and recreational came about that really opened up those markets. So, we were innovative, but we are lucky but we always thought that there was long term growth and the idea would be that we are investing in a theme that well not mainstream yet was going to be someday down the road be it five years or 15 years. So, in some cases we want to be ahead of the curve. 

We think of what we have done in the last couple of years as well we launched an ETF called RBOT, which is robotics and automation. And that again, think about medical practices you got to have eye surgery and the two specialists in town, one of them is 65 years old and he has been doing it for 35 years. He knows everything. But I am not 65, I am already – my hands isn’t always precise as I want it to be. If someone is cutting in my eye I want that precision. 

The other guy is a 30-year-old hotshot who’s got steady hands, but not the experience. So, if you look at what is happening in modern hospitals now, surgical procedures typically I have a friend of mine who is a surgeon. She said she’s got two robots in every surgery with her. So, for micro millimeter precision, they use the robot. So, this is the future, the development of this. We are not talking about fridges that tell you when you are out of milk. 

And we are talking about mainstream use and so things like robotics and automation and then as an off shoot to that, we launched an ETF called FOUR, which stands for industry 4.0, which robotics and automation, artificial intelligence, 3D printing, cloud computing. It is all about things that are becoming mainstream now, but we don’t recognize and people look at the names and they say, “Well that is not Sony. That is not Wells Fargo. That is not Goldman Sachs.” 

But the companies like NVIDIA that are growing like crazy and are involved in every day part of their life and they are just getting going. So robotics. And the other one would be blockchain and we are not investing in companies that we think will benefit from blockchain. We are investing in the software and hardware companies that are part of blockchain. People see blockchain as, “Oh you must be in the crypto currencies.” well no. 

Crypto currencies need blockchain. Blockchain doesn’t need crypto currencies. So, each of these examples were taking a mindset on things that are we think become members of the TSXXC or the SMP500 someday down the road. You know I think it will be a fascinating day in the press when Canopy or Aphria or one of these guys goes into TSX 60. There is so much going on in the future and you and I talked about this a little bit before. 

We don’t know who is going to survive, but we didn’t know who is going to survive in the internet boom. We didn’t know who is going to survive in the automobile industry at the turn of the last century when there are a hundred plus US auto manufacturers. So, we want to own the index for these things. Acknowledge that not everything is going to survive but not take the risk of doing individual stock selection in a market that we can’t predict is going to happen. 

Right, so that makes me think of an interesting question. Now I know you mentioned this when we were chatting before as well that Horizons just closed down a lot of products too. So what you just said makes me think of – well remind me to ask that question I guess, if we think about say HMMJ, say like you said there is consolidation and a lot of the companies don’t do well and overall the index as a whole doesn’t do well, at what point do you close down the product? What does that thought process look like? 

Well I think you look at it for two things, right? One from a selfish corporate perspective is profitable? I think we have shown historically the willingness to carry to loss leaders from longer than most because we believe in the idea. But we also look and say does it hold client interest? Like I think some of the things we’ve closed, when we have launched our active ETF business back in 2008, we had a value and a growth and a dividend ETF and they were all designed to look like their mutual fund counterparts, just cheaper.

We realized that the methodology and work didn’t attract clients, they didn’t care. We tried three different times with balanced ETF’s or two or three times with balanced ETF’s before finally hitting on what we have done now with our portfolios of our own ETF, just like we have seen Vanguard and iShares and BMO. You know there is no coincidences that the four largest ETF companies in Canada have all come to this point in time where we realize what the ideal structure this is going to look like. 

But you know I think about our younger days; we launched some things where we didn’t have as much market information. We didn’t have as maturity or rigor in our own process, but because the BetaPro ETF’s are really successful early and they are very profitable ETF’s we had money that we could try things out. So, while I think that we have carried on the spirit of innovation from our early days, our experience has made us better at selecting what to actually go forward with them or what not to.

That is interesting. There is one I don’t know if you remember this. I didn’t tell you; I was going to ask you about this, but there is one product that I looked at a while ago. It was Managed Future’s ETF and Managed Futures, the data around that is pretty good and there has been a bit of a resurgence I think in the sort of quant ETF approach and you guys were early to that, but it closed down. Why did it close down? 

Well it speaks to our history at Horizons like I talk about being the third guy and that is what we did, were Managed Futures and fund of funds. And funny, we have been in a quantitative easing environment for 10 years. Managed Futures really show their value when markets correct, when things zig and they zag. Without a zigging there is no sagging. So, they just weren’t going anywhere and as such, they weren’t compelling. Academically I believe in them hugely. 

They make sense if you put up an efficient frontier and you put a 20% allocation on Managed Futures. Historically, it does wonders for your portfolio, but unfortunately or historically while we had that product going was not one that was conducive to owning anything non-correlated, no negatively correlated but non-correlated. 

Because equity is our bond bull market maybe is at an end? But I mean we are seeing rates back down a little bit right now, which is good news for everyone with a floating rate mortgage and not going to be punitive to bond holders right now. But there has been no impetus to own alternatives. Just look at the Canadian Hedge Fund Association like the industry itself they are having a hard time. There are great products out there. There is really good ideas, but the market is not cooperating so. 

Right, yeah that is what I figured because like you said the performance wasn’t very good while the product is open for this Managed Future’s ETF but the idea is a pretty good one.

And unfortunately, it caused our most forward-thinking advisers who are in this when we call them and said, “look we are going to close this because it is not profitable. It hasn’t been profitable forever it hasn’t delivered any returns; we just can’t keep it going.” And they’re like, “well there is nowhere else for me to go.” Well, I am sorry but as much as we’d love to serve you guys and we don’t have an offset to it. 

It’s not like our Beta Pro ETF’s where all the money can be in the bear plus and very little in the bull plus but we look at them as a pair. We didn’t have anything to compare against that to say, “how long can we keep this going?” All ETF companies want to get hold of seed company, seed capital when they launch something and that only gets them to close their level of profitability because once you are out of seed capital, all the money that’s in seed capital – 

So, when you launch an ETF, someone gives you money to launch it. Let’s say you put $10 million in it. But if you, these seeding companies put in 10 million and you have only sold nine million, they are still sitting in seed. So, you are actually not making money on the millions still. Once you get through that, it starts being additive and that is where you start actually being profitable or breaking even and so that is really what we are looking at. Most ETF’s depends on the manufacturer and the pricing need 12 to 25 million dollars to be profitable.

So that is where everyone is making their decisions and it is for startups now it is difficult. How long can we keep going with this but not being proper? How deep pocketed are our investors and our backers? And so that is why I think the top four ETF companies in the country in which we’re number four, 88% of the market.

And we’re all relatively robust businesses. There is a lot of other ETF companies are now launched by mutual fund companies and banks that are coming up. So, they’ve got reserves to build up but the independent guys are in for a tough go just because the economics of launch. Sorry, the economics of launch are cheap. The economics of operation are difficult for point. 

Yeah, exactly. Cool, well I don’t have any other questions Jaime. Is there anything else that you want to add? 

No, I don’t think so. I have been just going back to you talking about the thematic. That would be the last part over the era of our innovation. Looking at this from our leverage ETF’s to the first beings who are true active to where we are passive trying to offer some value to clients to doing this thing a slightly different way to the thematic now. The other thing that we have done not just thematic is partnered with some firms that do very specific. 

So, we are partnered with Forstrong and they do a global macro ETF of ETF’s. Or we’ve got a Risk Parity ETF. So there’s all sorts of interesting side projects that we have going, but really our core business is the active and passive and we are excited to see where things go and keen to see some resolution to this budgetary issue.

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