HXS ETF & The HULC vs Conventional S&P 500 ETFs in a Taxable Account

Global X (formerly Horizons) swap-based corporate class ETFs may be useful in a personal taxable account. Their structure functionally avoids taxable foreign dividend income. Instead, the ETF accrues that amount as a capital gain. However, that comes at a cost: increased fees and some extra risks are embedded in the corporate class structure.

For those considering a tax-efficient way to track the total return of the 500 largest US companies, Global X’s HXS and HULC ETFs are options. How do they stack up compared to a conventional S&P 500 ETF? It depends. Learn why and use that to weigh the potential risks and benefits.


Mutual Fund Corporation vs Trust Investment Income

A corporate-class ETF has a structure different from that of conventional ETFs. The corp class ETF is one share class in a mutual fund corporation. So, the income from that ETF can be offset by expenses in other ETFs in the corporate family. If the net income across the MF Corporation family of funds is zero, there is no tax. The value of each ETF unit value rises by the amount of income minus its expenses. So, for the HXS or HULC ETF, dividend income effectively becomes a capital gain rather than a taxable dividend. Capital gains are generally taxed at half the usual income tax rate and only when the ETF units are sold.

In contrast, conventional ETFs are a trust structure. So, the income received must be paid out and taxed in the hands of the unit holders each year at the usual personal rates. That means there is a tax on dividend distributions every year.


Foreign Dividends & Withholding Tax

Foreign dividends are taxed as regular income. There is also a 15% foreign withholding tax (FWT) on US dividends. So, for a 2% dividend, there would be 0.30% FWT. Not a huge deal. Actually, in a taxable account, it is a nothingburger because you recoup that via a tax credit when you file taxes.

Importantly, a corporate-class ETF doesn’t pay tax (hopefully), but that also makes the FWT non-recoverable. The HXS ETF uses a swap contract to track the total return rather than receiving dividends, so it avoids FWT. In contrast, HULC holds stocks directly, and the FWT on dividends received is not recoverable. It would be recoverable using a conventional ETF.


Mutual Fund Corporation Tax Risk

The other feature of an MF corp is that losses from previous years can be carried forward and used to offset future income. In the case of Global X, they booked a large loss pool during the 2020 market swoon. Since then, they have had more income than expenses each year. That has caused the loss pool to shrink, but they have still not had net income.

The trouble occurs if there is net income inside the MF corp. If that happens, it is taxed at the business tax rate, which is 39.5% in the case of Global X. That tax paid within the corporation would be assigned to the ETFs that contributed to the net income and reduce their share value. When you sell, the total of that hidden tax plus your personal tax on a capital gain is higher than interest or foreign dividend income.


What could go wrong?

So far, there seems to be significant emotional reserve before angering the inner beast. However, you can only see the loss pool update for a year, the following spring, when Global X issues its year-end report for the ETFs.

That said, Global X has made some changes this year that may help calm the loss pool. Global X changed up their all-in-one ETFs (HEQT and friends) to use more conventional ETFs instead of the corporate-class ones. That may decrease income growth (but also decrease ETF return). They have also increased their swap fees as of Jan 1st, 2025. That increases expenses.

I suspect that Global X would initiate a rollover into a conventional structure if they saw trouble coming. However, there is always a risk of error. There would also be the management question of how to handle all of the unsettled swap income.

ETFs are a simple way to gain exposure to the broad US stock market. That could be as ETFs embedded within an all-in-one ETF that rebalances to maintain that exposure or as an individual ETF. There are many options to cover different swaths of the US stock market. The broadest US market exposure would be using a US total market ETF. Some examples would be VUN (or the US-listed VTI) or XUU (the US-listed ITOT). These include a range of large, mid, and small-cap companies. The S&P 500 is another commonly tracked US index and is where I will focus today.


S&P 500 Index

The S&P 500 consists of 500 large or mega-cap US companies. Size matters, but there are other criteria like profitability, liquidity, and a committee component. Historically, it has tended to have a very slight large-cap value tilt. The S&P 500 has caught people’s attention again recently due to a couple of banner years, but it has a long history. Many ETFs track the S&P 500, but VFV, ZSP, and XUS are some major Canadian-listed ones. I will just reference ZSP to keep it brief, but they are basically interchangeable. HXS also tracks the S&P 500 but uses swaps to track its total return and has a corporate class structure.


Solactive US Large Cap Index

The Solactive index used by HULC has slightly different criteria from the S&P 500. It is a market-cap-weighted index of the 500 largest US publicly traded companies. It tracks the total return (includes dividends) and is adjusted for FWT on the dividends and currency exchange into Canadian dollars (non-hedged). The result is not identical to the S&P 500. However, it is extremely close. The sector weightings are shown below.

hxs vs hulc etf

When you dig into the underlying holdings, they are largely the same companies with small (fraction of a percentage point) differences in weighting. No one can say whether the small differences matter or whether they are beneficial to either. However, since inception, HXS and HULC price changes have been almost identical with a high correlation. Before the recent HXS fee increase, the net fee/tax embedded in the ETFs was about the same.


S&P 500 Dividend Yield

The gross eligible dividend yield is the dividend paid per share divided by the share price. It may decrease when equity prices rise more than dividend payments and vice versa. So, it is constantly changing as stock prices and dividend amounts change. The dividends for the S&P 500 have changed over the past century.

In the last 25 years, the average dividend yield for the S&P 500 has been just under 2%/yr. However, with the rapid price increases in the post-pandemic era (particularly in big tech companies) the yield has most recently been down to the 1.5%/yr range. Whether that will continue is uncertain.

So, I will use a gross dividend yield of 1.75%/yr for my modeling.


Net Distributions or Growth

The gross yield differs from the distributions you see as an investor because distributions are made after fees and costs of the ETF are deducted. For example, ZSP, VFV, and XUS all have an MER of 0.09%. The FWT is 15% of 1.75% = 0.26%. So, the net dividend you’d receive is 1.40%. When you recover the FWT credit at tax time, then it is effectively still 1.66%.

For the corporate-class ETFs, the dividend yield would be captured as an increase in share price. In the case of the HXS ETF, it is blunted by the 0.11% MER plus an up to 0.50% swap fee. For HULC, the total return is blunted by the 0.10% MER and 0.26% loss to non-recoverable FWT.

Future returns are unpredictable, but I have arbitrarily set the capital gains at 6%/yr for modeling. So, for ZSP and the conventional ETFs that would be 6% capital gain plus a 1.66%/yr dividend for a total return of 7.66%/yr. For HXS, it would be a total return of 7.14%/yr, all as a capital gain. Assuming that the S&P 500 and Solactive’s index perform the same, HULC would expect a 7.39%/yr capital gain.


Passing Through All Gains Annually

Generally, a capital gain is attractive because it is taxed at half the usual rate compared to a foreign dividend. That is the simplified appeal of corporate-class ETFs. In the case of HULC, it is not quite as efficient because of the non-recoverable FWT. However, that is still much less than a taxable dividend.

If the ETFs were sold every year and tax paid on all dividends and capital gains, that lower capital gains rate results in a net advantage for HULC vs. a conventional ETF. That advantage grows to be substantial at the highest tax brackets. HXS also has the tax advantage of capital gains, but the high swap fee (assumed to be 0.50%/yr) takes a big bite—larger than the tax bite except in the highest tax brackets. This is shown using Ontario tax rates below.


Tax Deferred Growth

A lower taxable income is only part of the advantage of capital gains. Since that tax is not due until the ETF is sold and the capital gain is realized, there can be tax deferral, too. Tax deferral is generally advantageous because the money that would have been paid as tax stays invested and compounding longer. This is why it would usually not make sense to sell the ETFs before you have to.

The growth boost from not having a taxable dividend but a larger unrealized capital gain instead is shown below. Again, it is a larger net effect for HULC than HXS ETFs due to the lower embedded costs. This uses Ontario tax rates, but it would be similar for other provinces. Using corporate-class ETFs in Alberta, Saskatchewan, and Manitoba would have slightly less tax deferral advantage since their income tax rates are lower.


After-Tax Value When You Do Sell

The taxes on tax-deferred growth do eventually come due. When eventually sold, the extra capital gains that accrued (instead of dividends) will have tax due. One of the risks with ETFs is that you may be forced to realize the capital gain earlier than you’d planned if the ETF gets liquidated. Usually, that is a low risk if you stick with popular broad ETFs from major providers. Global X is a major provider, and these are broad ETFs. However, if there is a problem with the corporate class income management, it is not inconceivable.

To quantify the advantages and risks, I modeled how much more money you would have after tax if you sold at different points in the future. The higher your tax bracket now, the more of an advantage HXS/HULC would have (as mentioned). Deferral of the extra capital gains tax further into the future also helps.


HXS vs Conventional ETFs (ZSP/VFV/XUS)

The chart below shows the amount more you’d have due to HXS vs the conventional ETFs over time. The illustration below uses a taxable income of $200K in Ontario. An income level where HXS could make sense. Tax on dividends is removed annually for the conventional ETFs. The value at each time point is after the capital gains tax from liquidating the ETF. As you can see, there is a very small increase in the amount of after-tax money that grows over time. About 0.31% more after-tax money at 10 years. Double that at 15 years (gotta love compounding). It takes 13 years to break even at a higher capital gains inclusion rate, like 66.67%.

The HXS advantage is slightly better at higher tax brackets. At the highest Ontario tax bracket, the after-tax is 0.6% at 10 years and 1.2% at 15 years (data not shown).

The benefit of tax deferral is also impacted by the current vs future tax rate. If deferring from a high current to a lower future tax rate, the benefit grows. The reverse also applies. For example, deferring from a low tax bracket now and realizing a large gain that bumps you up tax brackets later could be detrimental.


HULC vs Conventional ETFs (ZSP/VFV/XUS)

I’ll repeat the above exercise using HULC. With its lower costs and corporate class efficiency, there is ~1.3% more after-tax money at 10 years (shown below). This is better than HXS or a conventional ETF, but not mind-blowing. At the top Ontario tax bracket, the advantage is a little larger: 1.6% at 10 years and 2.7% at year 15 (data not shown).

If deferring from a high current to a lower future tax rate, the benefit grows. The reverse also applies. For example, deferring from a low tax bracket now and realizing a large gain that bumps your tax brackets later blunts the benefit. However, the benefit was still larger than that of HXS or conventional. There wasn’t a period of potentially being underwater like there was with HXS unless the capital gains inclusion rate also increased.


Whether to use HXS, HULC, or a conventional ETF is a personal decision. I cannot give specific investing advice. Hopefully, this post will help you to make a more informed one as part of your own due diligence. It is a balance of potential risk and reward.


HXS vs HULC

The risk-reward balance is now pretty narrow with HXS. The HULC ETF still has more wiggle room due to the absence of swap fees. However, a couple of practical assumptions underpin the assumption that the HULC will smash HXS.

One is that Solactive’s index will have a similar overall return to the S&P 500. They are very similar but not identical, and the future could slightly favor one or the other. That is unpredictable, so I’d probably ignore it.

The other issue is that HULC is still a smaller ETF and trades on lower volumes. It has been growing and may grow more with the current changes. So, I am not too worried that it will close, but that is always possible. Volume is not a very accurate way of looking at ETF liquidity, but I would be sure to use best practices to avoid excessive market-maker shenanigans.


Potential Reward

The potential reward of using a corporate-class ETF is small at moderately high-income levels but could add up over longer time periods. The benefit is particularly powerful if selling the ETF tax deferral is taken advantage of. Deferring the income from a high current tax rate to a lower future tax rate is the most powerful.

The margin of benefit was significantly higher for HULC than for HXS. With HXS, there was even a reasonable risk of being worse off if there is a capital gain in the near future, bumping you up marginal tax rates and to a higher inclusion rate (like >$250K capital gains with the now zombie-like capital gains tax increase proposal).


Potential Risks

The unknown future is where another layer of risk enters on top of the usual investing risks. This analysis assumes that these funds have no net corporate income assigned to them from the corporate class structure. If there is net income, then it quickly becomes inefficient. Global X might be able to manage a conversion to a conventional ETF if they see that coming, but I am not sure how that would play out.

HXS has swap-based income. So, the risk of income is greater if they must settle swaps to manage their counterparty risk. That could happen with massive market rises. Despite the recent performance of the S&P 500, the counter-party exposure for HXS is only moderate (28%). The risk of income for HULC is from dividends received. I couldn’t find the yield of the underlying index, but it is likely in the 1.5-2% range. So, it is not very high.

The potential good news is that while the recent swap fee increase has made HXS less attractive, the increased costs may also make the corporate structure more sustainable. HULC would benefit from that stability without increased costs. I’ve done my best to model what the benefits could look like and discuss the potential risks. However, the biggest risks are always the ones you don’t see coming.

Disclosures: We currently hold HXS in one of our kid’s informal trust because I am too lazy to track income. We hold HULC in our corporate investing account which is where it may shine in our case.

8 comments

      1. Looking forward to ZDB vs HBB. Given the future unknowns, I currently have my fixed income (corporate account) split 50/50 between ZDB and HBB.

        1. Seems a reasonable approach. I think HBB is a bit less risky than the other corp class ETFs because its counterparty exposure is low and it is unlikely to have rapid growth (forcing settling swaps). However, the unexpected is still what gets you.
          Mark

  1. Do the TER’s need to be include in these calculations?

    HXS has a 0.29% TER and HXDM has a 0.30% TER. ENCC and a few other GlobalX ETFs have a TER less than the MER implying the TER is not included inside the MER and would be another drag.

    1. Hey AlphaDoc,

      The TER is essentially from the swap fees. It was 0.30%, but will be expected to gravitate towards 0.50% as the current increase works its way in. I went into the financial statements for each ETF (conventional too) to get TERs for this series. It was surprisingly high in some of the conventional ETFs coming up too.
      Mark

  2. Thanks for this. Just in time for me, as I am considering whether to do a zero-rate investment loan to my minor kids’ ITF accounts with excess personal funds. And if so, whether to use a corporate class ETF or just eat the attribution on the dividends and income.

    One question on the total return calculations. For ZSP (etc.) you have 6% gains + 1.75% dividends – 0.09% MER = 7.66% total return.

    But for HXS you have 7.75% gains – 0.11% MER – 0.50% swap. That equals 7.14%, but you later say 7.39% total return for HXS. Similarly, for HULC, 7.75% – 0.10% MER – 0.26% FWT = 7.39%, but you peg it at 7.64%.

    Clearly I am missing something. Where is this extra 0.25% return coming from?

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