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To quote wikipedia,

http://en.wikipedia.org/wiki/Index_fund#Synthetic_indexing
"Although maintaining the future position has a slightly higher cost structure than traditional passive sampling, synthetic indexing can result in more favourable tax treatment, particularly for international investors who are subject to U.S. dividend withholding taxes."

I know about the counterparty risk, but I'm mostly interested in synthetic ETFs for the purpose of investing in US dividend stocks, but I can't find a list of them. Can someone point me in the right direction?
 

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Discussion Starter #3
I believe the synthetic drip is done by the brokerage?
No, what I'm thinking of are synthetic funds (there might be a more common name, I don't know). They use swaps and a counterparty to convert their distributions to a more favorably taxed form. Claymore's Advantaged type funds are an example. Apparently they are much more common in Europe then in North America though.
 

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Great idea. Those Claymore funds are a great boon for Canadian investors seeking to reduce their tax exposure, postpone tax liability, or manage their income taxes, since you can choose when to realize capital gains.

It would be great if there were some funds that did this with US equities, as foreign dividends are taxed rather unfavourably.

Any thoughts on the counterparty risk with the Claymore funds? As I recall, it's some subsidiary of TD Bank. That it is a subsidiary is a somewhat concerning, as it limits the liability of the parent.
 

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there are various option strategies that serve to transmogrify US dividends - which are unfavourably taxed in canada - into most-favourably-taxed capital gains.

my choice is diagonal spreads. I prefer calls. I started with a pilot project in 2006/07. I was an experienced option trader. Mine are long-life diagonals, using LEAPs options as the long leg in place of underlying stocks, as would be the case with conventional buy/writes. The short or income leg consists of repeated sales of higher-strike otm calls.

somewhat to my surprise, the initial pilot group returned an average 17% per annum, all in the form of capital gains. The range among the individual positions is extreme since some inevitably fizzle while others double or triple within a short period. This overall return has maintained itself.

books have been written about these strategies. What i did discover:

1) because the option leverage can control 4 or 5 times the value in underlying US common stocks, therefore paper losses during any severe downtown such as we saw in 08/09 are limited;

2) the same leverage could guide an estate under the taxable radar if US democrats re-impose the pre-bush tax rules on foreign estates;

3) volatility is enormous, so an investor who is happy with risk will be comfortable;

4) diagonal trades require moderate rather than advanced option skills, although for efficient management purposes some positions will be temporarily naked & the investor should be recognized by his or her broker as a level 5 trader.

unlike futures, option strategies can be carried out easily & inexpensively by retail investors. Perhaps even better, option strategies don't depend upon individual counterparties. The option clearing corporations in both the US & canada serve as the counterparties, guaranteeing that the opposite side to a contract will be delivered against payment or taken up and paid for, as the case may be.
 

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Any thoughts on the counterparty risk with the Claymore funds? As I recall, it's some subsidiary of TD Bank. That it is a subsidiary is a somewhat concerning, as it limits the liability of the parent.
I've been doing a bit of research on this topic, especially with news today that Horizons BetaPro is introducing a TSX 60 index ETF that employs swaps. According to the prospectus, the counterparty risk appears to be limited to the returns you are expecting from the counterparty, not the collateral itself. It's probably the same for Claymore as well.

The ETF will be subject to credit risk with respect to the amount the ETF expects to receive from counterparties to financial instruments entered into by the ETF or held by special purpose or structured vehicles. The marked-to-market value of the exposure of the ETF to any one counterparty will generally not exceed 10% of the net asset value of the ETF and will at all times be in accordance with NI 81-102. If a counterparty becomes bankrupt or otherwise fails to perform its obligations due to financial difficulties, the value of an investor’s investment in Units of the ETF may decline.
 

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hmmmn i am inching way out on a limb here with wild intuitive imaginings plus readings of tealeaves in teacups and references to the study of entrails by shamans.

in 2006 & 2007 i knew that all that hi-paying mortgage-backed debt that was being marketed to us as those wonderful redeemable-anytime GICs was, in reality, very poor quality debt indeed.

when coventree failed out in BC in june 2007 i sensed that the jig was up in canada & began to slowly & quietly raise cash. This turned out to have been a very good idea.

now i'm beginning to get the same kinds of jizzy feelings about the proliferation of "funds" consisting of futures, swaps, repos & reverse repos & so on. At least with options, the clearing corporations themselves guarantee delivery of shares or money. At least with stocks traded on the organized senior exchanges, the delivery of shares or money is guaranteed. Of course there is naked shorting, although that's mostly over-the-counter or pink sheets. And there are worrisome numbers of shares gone FTD even in the senior exchanges. But at least there are quasi regulated bodies that are presumably in charge of definable structures.

now with all these futures-based funds what kind of regulatory framework is present. Seems to me some of these funds consist of not much more than a few phone calls. Phone calls to whom ? and to what ? Your counterparty may be a bank, but are they actually guaranteeing anything at the said bank. Or are they just dealing you through to the real counterparty, who could be in abu dhabi or colombia or panama or drug-money-three-steps-removed. Is there anybody or anything in charge here anymore ...
 

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now with all these futures-based funds what kind of regulatory framework is present. Seems to me some of these funds consist of not much more than a few phone calls. Phone calls to whom ? and to what ? Your counterparty may be a bank, but are they actually guaranteeing anything at the said bank. Or are they just dealing you through to the real counterparty, who could be in abu dhabi or colombia or panama or drug-money-three-steps-removed. Is there anybody or anything in charge here anymore ...
The answer seems to be "we don't know". I read the prospectus of HXT a couple of times but I'm not able to get a handle on how much counterparty risk there is. The prospectus says that in the event of counterparty default, 10% of the mark-to-market value of the swap, which cannot exceed 10% of NAV is at risk. But has it been tested before? Are the contracts watertight? I really don't know enough, so it's "wait-and-watch" for me.

XIU, by contrast, is very transparent. It holds a bunch of stocks and even if BlackRock ever gets into trouble, XIU holdings belong to unit holders. It's a simple structure that even a child can understand. HXT is much more complicated and I have trouble wrapping my mind around it. And when I don't understand something, I tend to avoid it.
 

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Fair enough. These swap arrangements have certainly made me cautious, but the tax efficiency is pretty tantalizing, especially in bond funds. The only one that I'm aware of with significant track record is CAB, which is a broad bond index fund. One also has to figure that slightly higher MER for (some of) these funds when compared to more vanilla ETFs, but being able to transmogrify current interest income into return of capital is pretty advantageous, especially for longer holding periods.
 

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Canadian Capitaliast said, in his reply:

"And when I don't understand something, I tend to avoid it. "

These are very smart investing words.......very smart.....and a rule everyone should stick with.
 
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