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Monty Spivak
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Technology and business consultant, who invests in Canada Europe, Australia, and USA. Deep financial sector and financial services experience from both business and technology perspectives. A do-it-yourself income investor, who is always evaluating and seeking high-yield and long-term, long... More
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  • Horizons Gold Yield Fund - Canadian IPO for Yield and Gold 1 comment
    Dec 15, 2010 4:09 PM
    There is a new fund Initial Public Offering (IPO) on the Toronto Stock Exchange (TSX) which will interest yield-hungry investors who want to hold gold. There are some important trade-offs to consider before buying the units.
    If you want to buy gold-based securities, but prefer a steady interest or dividend yield instead the potential for capital gains, then there are a few alternatives. I had explored some choices in an article, Buy Gold Without Sacrificing Yield. The conclusion reached is that the gold funds that provided the highest yields were Closed-End Funds (CEFs). Most of the holdings of these funds are gold-mining companies, which do not correlate perfectly to the price changes of gold, but are a reasonable proxy. Despite different investment strategies and holdings, the gold CEFs have significantly increased in value and continue to generate their stated yield.

    The new player moving into this space – Horizons AlphaPro - has tabled an IPO for the Horizons Gold Yield Fund (which will trade as TSX/HGY.UN, beginning in December, 2010). To summarize the key points in the prospectus (76 pages, dated November 26, 2010, and available on
    www.sedar.com), this fund provides the investor exposure to the price of gold bullion, while providing monthly distributions. It is a unique offering in a few ways:

    1.
          
    It is a gold-commodity fund, rather than a gold-producer fund. The securities that they invest in are gold-bullion funds.
    2.       It is hedged to the Canadian dollar, which will provide US investors currency diversification, and Canadian investors protection against US dollar currency fluctuations.
    3.       This is a managed fund; in other words, the fund does not passively match the performance of benchmark commodity, securities, or indices – fund managers make decisions on when to buy and sell the securities and options.
    4.       They commit NOT to use leverage (borrow money to increase yield). Without getting too technical, this should cause the price of HGY.UN to behave more like the price of gold bullion than follow the market pricing of the stock market – a good thing for people seeking to invest in gold as a hedge for currency and securities risks. The other side of this feature is that leverage could substantially enhance yield; the fund’s borrowing rate would be near-zero for the foreseeable future, so borrowed money would enhance the portfolio’s income.
    5.       They will “treat gains or losses on any disposition of Canadian Securities Portfolio securities acquired under the Forward Agreement as capital gains and losses”, so there may be tax advantages to the return. This will also depend upon each investor’s tax situation.
    6.       Monthly distributions, initially expected to be $0.0542 per unit ($0.65 per year) would yield 6.5% on the issue price of $10.00 (CAD) per unit.
    AlphaPro plans to sell call options – forward purchase and sale agreements – to generate income from bullion security holdings:

    The Portfolio Manager intends to write at-the-money covered call options on approximately, and not more than, 33% of the securities in the Gold Portfolio. The Portfolio Manager will not manage the call option writing strategy to achieve a specific target return, but will manage it to generate attractive option premiums that temper the volatility associated with owning a portfolio of securities that provide exposure to the price of gold bullion.

    The targeted bullion fund holdings and options, based upon which securities that AlphaPro would exchange for fund units, are:
    Exchange / Eligible Issuer
    Trading Symbol
    Canadian Based Exchange-Traded Funds
     
    Claymore Gold Bullion ETF
    CGL
    Horizons BetaPro COMEX Gold Bullion Plus ETF
    HBU
    Horizons BetaPro COMEX Gold ETF
    HUG
    Horizons BetaPro S&P/TSX Global Gold Bull Plus ETF
    HGU
    iShares CDN S&P/TSX Global Gold Index Fund
    XGD
    United States Based Exchange Traded Funds
     
    Goldman Sachs Commodity Index (GSCI) Total Return Index ETF
    GSP
    iShares COMEX Gold Trust ETF
    IAU
    PowerShares DB Gold Fund ETF
    DGL
    SPDR Gold Shares ETF
    GLD
     
    The IPO price is $10.00 CAD, and the plan is to start this as a CEF and then move to a managed Exchange Traded Fund (ETF) between January 31 and July 31, 2012. There are trade-offs with this approach, which I have outlined in the following table - which compares a similar managed-fund IPO that started as an ETF (both information sources are the respective prospectuses and AlphaPro website).
    Feature
    Horizons Gold Yield Fund (TSX/HGY.UN)
    Horizons AlphaPro Seasonal Rotation ETF (TSX/HAC).
    Fund model
    Start this as a Closed-End Fund (CEF) and then move to a managed Exchange Traded Fund (ETF) between January 31 and July 31, 2012
    Launched as an Exchange Traded Fund (ETF)
    Objective
    The fund will provide the investor “low cost exposure to the price of gold bullion hedged to the Canadian dollar, while providing monthly tax-efficient distributions.
    This fund will “provide long term capital appreciation in all market cycles by tactically allocating its exposure amongst equities, fixed income, commodities and currencies during periods that have historically demonstrated seasonal trends”.
    Fund size
    Minimum size is $20 million; maximum is $100 million. The IPO ended-up at $50.3 million CAD.
    There are currently over 3 million units currently issued, with a NAV of about $33 million.
    One-Time Fees (Note: Most Upfront Fees are paid by the fund)
    1.       The usual overallotment option (a one-time privilege, where the agent may buy 15% more of the shares issued, at the issuance price).
    2.       The Agent’s fee alone is 5.25% for the retail investor. If you go through a broker/dealer/advisor, the stated Agents Fee is only 2.25% (plus whatever you pay to the intermediary, so it will probably cost you 5.25% in any event). 
    3.       The Expenses of the Offering is $750k to a maximum of 1.5%.
    1.       Expenses of the Issue – not clearly identified in the prospectus, but 1.5% is a reasonable proxy.
    2.       Redemption Fee – the other fees are paid by the fund; this one is paid by the investor. It is up to 0.25% of the redemption proceeds of the ETF.
    Annual / Operating Fees
    4.       Management Fees will be 0.30% of the NAV (Net Asset Value – the total value of the fund assets).
    5.       Counterparty Fee will be 0.35% of the NAV.
    6.       Service Fee will be about 0.30% of the NAV.
    7.       Operating expenses $750k/year; let’s call this about 1%, should the fund start with $75 million.
    8.       Fees and Expenses Payable by the Gold Yield Trust are 0.30% of the NAV, plus $75k Operating expenses (about 0.1%).
    3.       Management Fee is 0.75% of the NAV.
    4.       Performance Fee (if any), equal to 20% of the amount by which the performance of the ETF is greater than an annualized return of 5% (or a related complicated formula).
    5.       Operating Expenses – not clearly identified in the prospectus, but 2% is probably reasonable.
    Fee Summary
    The upfront fees (items 1 – 3) are high. If the fund starts with the maximum $100 million, the agent’s fees and expense of the offering will reduce the fund NAV to $94 million, before one penny is invested. The operating fees, items 4 – 8, add over 2% per year to the cost. I should leave you to do the math, but it is clear that over 8% of your investment is going to fees in the first year, before the fund invests or earns anything.
     
    As well, should investors only participate up to $75 million, the $825 thousand flat portion of the operating fees will become a larger percentage (1.65%) of the fund overhead.
    It appears that the annual fees will total around 3%, with one-time fees of about 2%. Therefore the ETF has a 5% overhead in the first year. The small market cap of the ETF creates high Operating expenses. The cost of this ETF is lower than the CEF, which has very high issuance fees, due to the Agent’s fee of 5%, compared to the ETF issuance fee of around 2%.
    Other attributes
    No leverage.
    The fund will use leverage – up to 120% of the NAV, securities lending, and short-sales (options) to enhance return.
     
    I briefly discussed this IPO with Mark Noble at AlphaPro. He was professional and articulate. Horizons AlphaPro provided a written formal response, which encapsulates the fund manager’s perspective on launching the Horizons Gold Yield Fund as a Closed-End Fund, instead of the future ETF:

    Launching a mandate as a closed-end fund instead of an ETF right away creates a couple of advantages. The primary reason is that it usually allows a mandate to gather a larger asset base more quickly which creates efficiency with the pricing and trading that may benefit the end investor. Eventually, the fund will convert to an ETF in 2012, and we’ve found that the closed-end structure in the past has allowed for a greater number of assets to flow into the mandate initially creating better efficiencies for the portfolio.
    Interestingly, because investors know that our closed-end funds will convert to an ETF they tend to trade very close to the net asset value (NAV) of the underlying securities. The most significant criticism of closed-end funds – which is the fluctuation in share price from NAV has not been much of an issue for our converting closed-end funds.
    You should also keep in mind that there are both F-class and A-class versions of this fund. The F-class will not pay a trailer, so the investor will save some money there in fees. However, this is a fund that will only be offered through advisors initially due to the nature of the syndicated initial public offering.

    It seems that the fund manager does not charge as much for the upfront fees on an ETF. In addition to substantially reduced fees, some of the benefits of an ETF structure are clearly laid-out in the Horizons Gold Yield Fund prospectus:

    Conversion of the Fund into an ETF is expected to provide Unitholders with a number of benefits, including potentially greater market liquidity, potentially more efficient trading as the market price of the Class E Units is expected to be closer to the Fund ETF’s NAV and the potential ability to increase the asset base for the Fund ETF as a result of the continuous offering of its units as an ETF. In addition, in the event there is lack of liquidity for trading the Units prior to the Conversion, Unitholders who want to trade large positions of Units may have a significant impact on the market price. As an ETF, Unitholders should be able to buy and sell their Class E Units of the Fund ETF without materially affecting the market price of the Fund ETF on a relative basis as a result of increased liquidity.
    The bottom line when comparing the Horizon AlphaPro CEF to the ETF:
    1.       Managed ETFs from Horizons AlphaPro appear expensive – particularly when compared to US funds. The bet is that the fund managers will outperform the expected market return.
    2.       In the first year, the CEF model of the Horizons Gold Yield Fund will charge investors 60% more in fees (8% compared to 5%) than the ETF model of the Horizons AlphaPro Seasonal Rotation ETF. This is directly reducing the fund’s NAV and the return.
    3.       There may be trade-offs between the market launch and pricing behaviour of the CEF and ETF, as described by both AlphaPro’s representative and the fund prospectus, but the differences do not seem to warrant the higher-cost IPO model.
    A very important question is whether the distribution is sustainable. Can the fund earn investors the published initial return over a longer term? According to the prospectus, there are a few major assumptions:
    Assuming an aggregate size of the Offering of $100 million and the fees and expenses described under “Fees and Expenses”, the Gold Portfolio would be required to generate an average total return of 8.75% per annum in order for the Fund to maintain a stable net asset value (“NAV”) and to fund the Fund’s distributions at the initial distribution amount through partial pre-settlements of the Forward Agreement. Based on (i) the average current volatility of the price of gold bullion, and (ii) the other assumptions set forth under “Investment Strategy”, the Gold Portfolio would be expected to generate a return in excess of the above required return.
    Of course, the risk of the distribution being reduced (or increased) depends on your outlook for gold. If the price of gold bullion remains flat, only limited income will be generated from the portfolio. If it climbs (more than 8.75% per year), then you can be a winner. This is the only gold/yield fund based exclusively on gold bullion, so it should behave similarly to the price of the commodity. A slow and steady rise in the price of gold bullion would permit this gold fund to outperform others, and is clearly an underlying assumption.

    I telephoned my discount broker, and was advised that there is little retail interest in the Horizons Gold Yield Fund. The advertizing and promotions are focussed in the brokers and investment advisors. If you plan to buy this fund, then it may be beneficial for the retail investor to wait until the CEF is converted to an ETF in 2011. As stated by Horizons AlphaPro, “Granted, for a direct investor who doesn’t use an advisor, the ETF will likely be cheaper than buying the fund through the IPO. That said, conversion is not expected until sometime in 2012, the investor has to decide whether they want to access this type of strategy now to take advantage of prevailing market conditions or if they want to wait for conversion. We can’t answer that question for the advisor.

    There are alternatives. In addition to the alternative funds mentioned in the previous article, you can do it yourself, and create your own gold-yielding investment. Unlike funds of gold-mining stocks, there is a very narrow universe of gold-bullion EFTs. There is the possibility of executing gold-bullion securities and options trades to earn your own return on gold bullion. You can buy bullion fund units and sell covered calls in order to earn capital gains, without the 8.75% overhead of this fund. I recommend that only experienced investors investigate this alternative, as there are high risks (as at today, I have personally chosen not to pursue this strategy). That said, a fellow SA member (Smarty_Pants) has had success with this approach, and I plan to gather more facts and discuss his strategy in a future article.

    To summarize, the Horizons Gold Yield Fund is a compromise investment for those who want both a gold holding and income stream, but beware - the upfront and annual fees are substantial. Nobody would expect a guarantee that an investment in the fund would earn a positive return, and this is clearly disclaimed in the prospectus. That said, unless gold behaves in a very volatile manner, and increases substantially in value each year, the yield may be difficult to achieve. The less less risky and more cost effective option may be to wait one year, observe the performance, and then decide if you should buy the units after they convert to an ETF. Only you can decide whether the Horizons Gold Yield Fund strategy and net return align with your risk appetite, forecast for gold prices, and investment objectives.


    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
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Comments (1)
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  • Author’s reply » Hi,

     

    Just a quick update for those who are interested in Canadian gold funds, and a continuation of my assessment of HGY (now called: Horizons Gold Yield ETF).

     

    HGY has converted to a fund, and is trading at its NAV of just under $10.00 CAD; the fund cap is under $70M CAD; and, is yielding (including ROC) 9.4%. The link for detailed information is: http://bit.ly/zdhs7Z

     

    Cheers, Monty
    11 Mar 2012, 11:25 AM Reply Like
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