It’s little surprise the innovation comes from Purpose. The company’s CEO is Som Seif, who founded Claymore Investments back in 2005. Claymore was an ETF pioneer: they were the first to offer pre-authorized cash contributions (PACCs), dividend reinvestment plans (DRIPs) andsystematic withdrawal plans (SWPs). Then they teamed up with Scotia iTRADE to offer the first commission-free ETF program. Seif exited Claymore after they were bought by BlackRock in 2012, and it was only a matter of time before he got behind a new project that shook up the ETF business.
Before looking at the new ETFs, let’s review how corporate class funds work. Most mutual funds are structured as trusts. Income flows through to investors and retains its character: in other words, if you receive Canadian dividends, foreign dividends, interest or capital gains, you pay tax on that income as if you had earned it from stocks and bonds you held directly. And any time you sell units of a mutual fund trust for more than you paid, you’ll incur a taxable capital gain.
Corporate class mutual funds are not trusts: they’re corporations. A single corporation is set up to hold several funds, each structured as a different share class. For example, a single mutual fund corporation might include a Canadian equity fund, the US equity fund and a bond fund. If you switch between an equity fund and the bond fund—while rebalancing your portfolio, for example—no actual sale has taken place. This allows an investor to defer capital gains until the shares are eventually sold. Unlike trusts, corporate class funds can’t pass along all their income to shareholders, so they also tend to have fewer taxable distributions.
To use an analogy, think of mutual fund trusts as individual houses. In order to move, you need to sell one house and buy another. Corporate class funds are more like a single house with several rooms: you can move from one room to the other without selling anything.
Flipping the switch
Purpose Investments currently has five funds under its corporate class umbrella:
PURPOSE TOTAL RETURN BOND FUND ETF(TSE:PBD)
Purpose Fund Corp(TSE:PDF)
PURPOSE MONTHLY INCOME FUND ETF(TSE:PIN)
PURPOSE DIVERSIFIED REAL ASSET FUND ETF(TSE:PRA)
Purpose Fund Corp(TSE:PHE)
If you hold more than one of these ETFs, you can move from one to another without placing orders to sell and buy. Instead, you request a switch. Currently you can do this once a week, with the cut-off being 4 pm every Tuesday. On Wednesday, shares of the old ETF will be exchanged for shares of the new ETF according to a “switch ratio” that reflects their relative price difference. Only whole shares can be switched, and any fractional amount will be paid in cash.
Now the big question: how exactly do you accomplish this switch? If you use an advisor, you can let him or her worry about the details. But if you’re a do-it-yourselfer, you need to pick up the phone and call your brokerage, since there is no way you can make the switch online.
At this point it’s not clear how easy this will be: in a recent discussion with Som Seif, he explained the switch is a type of “reorganization,” similar to what you’d do if you held a convertible bond and wanted to convert it to the company’s stock. Customer service reps will be familiar with this procedure in general, but they won’t have any experience with corporate class ETFs. Purpose Investments has given the brokerages a heads-up, but it’s quite possible you’ll get someone on the phone who has no clue what you’re talking about.
Claymore ran into the same issues when it introduced its PACC, DRIP and SWP plans several years ago. There is no technical or regulatory reason why these transactions can’t be done. But in practice, brokerages are slow to embrace these innovations, since they have little to gain: it involves more work and less revenue from trading commissions. Some brokerages still don’t support PACCs and SWPs, which helps explain why BlackRock grandfathered them for the old Claymore ETFs but has not extended them to the rest of the iShares family.
Will be watching to see if the corporate class structure catches on with ETF investors, and whether other providers will consider following suit.
By: Dan Bortolotti
This Article was brought to you Courtesy of the “Canadian Couch Potato.”
Canadian Couch Potato is designed for Canadians who want to learn more about investing using index mutual funds and exchange-traded funds (ETFs). In 2011, it was selected by The Globe and Mail as the best investing blog in Canada. The blog’s author is financial journalist Dan Bortolotti, author of The MoneySense Guide to the Perfect Portfolio, a complete guide to index investing in Canada.