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Horizons crossing the border with launch of new ETF

The North American market is saturated with mutual and exchange-traded funds, but one Canadian-born ETF provider sees room south of the border for just a few more.

Toronto-based Horizons ETFs Management (Canada) Inc. will launch in its fifth market today with just one investment offering on the New York Stock Exchange: the Horizons S&P 500 Covered Call ETF. Covered-call ETFs made up just 3.3 per cent of the industry as of 2012. Canadian investors have been attracted to them because they generate income in the low-rate environment, without taking on too much risk.

These ETFs have sold well in Canada, and Horizons now has $500-million in a family of 12 covered-call ETFs. In 2011, South Korean investment firm Mirae Asset Global Investments Co. Ltd. bought a majority stake in Horizons, and the company now runs 140 ETFs through South Korea, Hong Kong and Australia.

But even with that global experience, how does Horizons plan to compete against U.S.-based ETF giants such as Vanguard Group Inc. or BlackRock Inc.?

"It's always a challenge going into a mature market, but I think we have a few things going for us," said Howard Atkinson, managing director for Horizons USA. Most importantly, Mr. Atkinson said Horizons isn't going head-to-head with anyone. "There are no other ETFs that sell single-stock call options on an index, especially with the S&P 500, which is probably the best-known U.S. benchmark."

Another reason Horizons was able to break into this niche was due, in part, to the regulations that govern mutual funds and ETFs in Canada. The regulators here are already familiar with ETFs that use covered calls, so the lag time on getting the investment products approved was shorter. And having the track record in Canada helped Horizons partner with Standard & Poor's Corp.

"To launch an index-based ETF off a legitimate third-party index provider was relatively straight forward, " Mr. Atkinson said. Still, developing the index methodology took close to 18 months. The stock needs to be priced above $10, for example, and the option must be able to be sold at 15 cents or more, or it's not worth writing.

The formula involves selling call options on stocks in the ETF's underlying portfolio. Covered calls work by guaranteeing buyers the opportunity to purchase a stock from its owner at a certain price for a specified period of time. Buyers pay a premium for that opportunity. In an ideal scenario for the ETF, the stock price goes up a little, but not enough to be called away by the buyer.

But this strategy is not universally adored. Critics argue that investors may be missing out on a lot of the stock's upside in their pursuit of yield - sometimes the funds underperform their regular equity counterparts. And in different market conditions, the option premiums can be more, or less, profitable, which adds some volatility.

Still, Horizons is betting the ETF will be a hit, and it has already filed applications with regulators for two more covered-call ETFs in the financial and energy sectors. It's also exploring other types of products that might be suitable for Americans.

© 2007 The Globe and Mail. All rights reserved.

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