Do ETFs have the same issue as mutual funds at year end (distributions)?

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billthecat
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Do ETFs have the same issue as mutual funds at year end (distributions)?

Post by billthecat » Sun Dec 10, 2017 11:11 pm

I've seen commentary about how one should avoid adding money to mutual funds near year end because of the distubitions from such funds, which would be subject to taxation.

Do ETFs have the same issue?

lack_ey
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Re: Do ETFs have the same issue as mutual funds at year end (distributions)?

Post by lack_ey » Sun Dec 10, 2017 11:25 pm

Depends on the ETF and mutual fund.

With respect to dividends, ETFs have to distribute those just as mutual funds do. ETFs do tend to have less capital gains distributions than mutual funds, though. For one, most ETFs are index funds and have lower turnover than the typical mutual fund, which is actively managed. But even if you do a fair comparison between ETFs and mutual funds following the same strategy (say a large cap index fund), the ETF will typically have lower—frequently zero—capital gains distributions on average, lower than the equivalent mutual fund. This has to do with the redemption mechanism and trading differences in the structures.

If investors want to sell an ETF, they just sell to somebody else on the market. That doesn't result in the ETF manager having to sell assets. If there are more people who want to sell than buy, then some authorized participants (institutional traders) can gather up ETF shares and then trade them in (with the manager) for underlying assets. Again, that doesn't result in shares needing to be sold by the ETF manager, and the ETF can jettison some low-cost-basis shares in the process. On the other hand, a mutual fund does need to sell assets to meet fund redemptions. So structurally ETFs have the advantage here.

Vanguard index funds are run with a dual share structure, combining the mutual fund shares and ETF shares into one underlying investment pool, so they can usually avoid capital gains distributions even for those mutual funds.

alex_686
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Re: Do ETFs have the same issue as mutual funds at year end (distributions)?

Post by alex_686 » Mon Dec 11, 2017 12:14 am

Technically yes. They are both governed by the same rules and regulations.

For dividends they are equlivent.

For capital gains they are not. When mutual funds liquidate they sell, and selling is a taxable event. When ETFs liquidate, they swap ETF shares for the underlying assets. Swaps are not taxable events. This is why ETFs are considered more tax efficient than mutual funds as a general rule.

In 2008 during the fininical crisis some small illiquid ETFs ran into problems and actually liquidated their assets triggering large taxable distributions.

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Re: Do ETFs have the same issue as mutual funds at year end (distributions)?

Post by livesoft » Mon Dec 11, 2017 5:11 am

Yes, they have the same issue. Vanguard ETFs will pay dividends and capital gains distributions just like Vanguard mutual funds. One can look at the historical record and see this.
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Re: Do ETFs have the same issue as mutual funds at year end (distributions)?

Post by grabiner » Wed Dec 13, 2017 9:46 pm

Stock ETFs will rarely pay capital-gains distributions, except just after getting started. For example, Vanguard FTSE All-World Ex-US Small-Cap started near the 2009 market bottom. In 2009 and 2010, it had to sell shares to handle index changes, and everything was way up, so it distributed some capital gains.

REIT Index is the only Vanguard stock ETF which distributed a capital gain other than just after getting started, and it hasn't distributed one since 2008.

But to deal with the end-of-year issue, you can look at projected distributions. I wanted to buy FTSE All-World Ex-US Small-Cap in late 2010, but I knew it would pay a capital gain, so I waited until the day the gain was paid. For funds which aren't distributing a gain, and which pay dividends quarterly, it isn't worth waiting; a 0.5% qualified dividend results in $8 tax on a $10,000 investment.
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Re: Do ETFs have the same issue as mutual funds at year end (distributions)?

Post by JustinR » Wed Dec 13, 2017 10:42 pm

grabiner wrote:
Wed Dec 13, 2017 9:46 pm
Stock ETFs will rarely pay capital-gains distributions, except just after getting started. For example, Vanguard FTSE All-World Ex-US Small-Cap started near the 2009 market bottom. In 2009 and 2010, it had to sell shares to handle index changes, and everything was way up, so it distributed some capital gains.

REIT Index is the only Vanguard stock ETF which distributed a capital gain other than just after getting started, and it hasn't distributed one since 2008.

But to deal with the end-of-year issue, you can look at projected distributions. I wanted to buy FTSE All-World Ex-US Small-Cap in late 2010, but I knew it would pay a capital gain, so I waited until the day the gain was paid. For funds which aren't distributing a gain, and which pay dividends quarterly, it isn't worth waiting; a 0.5% qualified dividend results in $8 tax on a $10,000 investment.
I thought Vanguard mutual funds and ETFs equivalents were basically the same? How can one have capital gains distributions but not the other?

From the wiki:
Most Vanguard ETFs have no tax advantage over the corresponding Vanguard index funds, because in most cases the ETF is a share class of the index fund and thus the mutual fund shares the tax benefits of the ETF.

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wshang
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Re: Do ETFs have the same issue as mutual funds at year end (distributions)?

Post by wshang » Wed Dec 13, 2017 10:53 pm

I'm trying to decide whether to buy VO versus the VIMEX Vanguard equivalent. One potential consideration is the FIFO rule provision in the present legislation under consideration. This would sway me to the mutual fund side.

Does anyone know any difference between these two? I couldn't discern any dividend or capital gain distribution nor significant post tax performance difference.

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Re: Do ETFs have the same issue as mutual funds at year end (distributions)?

Post by grabiner » Thu Dec 14, 2017 8:55 pm

JustinR wrote:
Wed Dec 13, 2017 10:42 pm
grabiner wrote:
Wed Dec 13, 2017 9:46 pm
Stock ETFs will rarely pay capital-gains distributions, except just after getting started. For example, Vanguard FTSE All-World Ex-US Small-Cap started near the 2009 market bottom. In 2009 and 2010, it had to sell shares to handle index changes, and everything was way up, so it distributed some capital gains.

REIT Index is the only Vanguard stock ETF which distributed a capital gain other than just after getting started, and it hasn't distributed one since 2008.

But to deal with the end-of-year issue, you can look at projected distributions. I wanted to buy FTSE All-World Ex-US Small-Cap in late 2010, but I knew it would pay a capital gain, so I waited until the day the gain was paid. For funds which aren't distributing a gain, and which pay dividends quarterly, it isn't worth waiting; a 0.5% qualified dividend results in $8 tax on a $10,000 investment.
I thought Vanguard mutual funds and ETFs equivalents were basically the same? How can one have capital gains distributions but not the other?
This is correct. The mutual funds are just as good at avoiding capital gains as the ETFs. I bought the ETF class of FTSE All-World Ex-US Small-Cap, but waited to avoid the capital gain. My point is that this was an unusual situation, and also one which could easily be identified; Vanguard reported that the fund was likely to distribute a capital gain of more than 2%.
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Re: Do ETFs have the same issue as mutual funds at year end (distributions)?

Post by Alan S. » Thu Dec 14, 2017 10:06 pm

So in the usual ETF structure, the cap gains will be depressed compared to the equivalent mutual fund. With VG's structure the equivalent mutual fund cap gains are also depressed like the ETF.

Further, with VG's structure the ETF and equivalent mutual fund shares can be exchanged without a taxable event. With most other firms, there would have to be taxable sale and re purchase.

That's two advantages with VG's structure. But there must be some disadvantages. What are they?

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Re: Do ETFs have the same issue as mutual funds at year end (distributions)?

Post by alex_686 » Thu Dec 14, 2017 10:09 pm

Alan S. wrote:
Thu Dec 14, 2017 10:06 pm
That's two advantages with VG's structure. But there must be some disadvantages. What are they?
None that I know of. Vanguard invented this particular dual class structure and patented the idea. I assume others will copy this structure once the patent expires.

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Re: Do ETFs have the same issue as mutual funds at year end (distributions)?

Post by grabiner » Fri Dec 15, 2017 9:27 pm

Alan S. wrote:
Thu Dec 14, 2017 10:06 pm
So in the usual ETF structure, the cap gains will be depressed compared to the equivalent mutual fund. With VG's structure the equivalent mutual fund cap gains are also depressed like the ETF.

Further, with VG's structure the ETF and equivalent mutual fund shares can be exchanged without a taxable event. With most other firms, there would have to be taxable sale and re purchase.
One way only; you can convert a mutual fund to an ETF but not vice versa.
That's two advantages with VG's structure. But there must be some disadvantages. What are they?
In theory, having both mutual fund and ETF share classes should dilute the tax benefits of the ETF. A fund which is half mutual fund and half ETF can only unload half as many shares in redemptions as a pure ETF, but will have just as much in forced sales when the index changes.

But in practice, this hasn't been an issue. REIT Index is the only Vanguard stock ETF which paid out distributions that might have been avoidable for a pure ETF. The other two stock ETFs to distribute capital gains, Consumer Staples and FTSE All-Word Ex-US Small-Cap, are almost pure ETFs; in addition, both distributed gains just after getting started in a rising market, a situation in which even pure ETFs usually distribute gains.
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Re: Do ETFs have the same issue as mutual funds at year end (distributions)?

Post by MnD » Fri Dec 15, 2017 11:01 pm

This small cap international ETF wins no prizes as far as lack of distributions. 2017 wasn't another 2014 (yikes) but still not great.

https://us.spdrs.com/en/resources/distr ... x_code2=NA

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Re: Do ETFs have the same issue as mutual funds at year end (distributions)?

Post by grabiner » Sat Dec 16, 2017 9:23 pm

MnD wrote:
Fri Dec 15, 2017 11:01 pm
This small cap international ETF wins no prizes as far as lack of distributions. 2017 wasn't another 2014 (yikes) but still not great.

https://us.spdrs.com/en/resources/distr ... x_code2=NA

Image
GWX and EWX have had distribution problems; none of the other international small-cap ETFs have distributed capital gains other than just after getting started. (This is updated annually on the International small cap) wiki page.
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Re: Do ETFs have the same issue as mutual funds at year end (distributions)?

Post by MnD » Sun Dec 17, 2017 11:12 am

grabiner wrote:
Sat Dec 16, 2017 9:23 pm
MnD wrote:
Fri Dec 15, 2017 11:01 pm
This small cap international ETF wins no prizes as far as lack of distributions. 2017 wasn't another 2014 (yikes) but still not great.

https://us.spdrs.com/en/resources/distr ... x_code2=NA
GWX and EWX have had distribution problems; none of the other international small-cap ETFs have distributed capital gains other than just after getting started. (This is updated annually on the International small cap) wiki page.
Both GWX and EWX have a market cap dollar-based limit of $2 billion for inclusion per below. I think this results in growing and successful companies continually capping out above the $2B index limit and being sold after significant appreciation or even just through inflation. Vanguard small cap international uses a percentage band approach (86%-98% smallest) with buffers to reduce turnover.
https://www.bogleheads.org/wiki/FTSE_Gl ... x_US_Index

Given the distribution problem for GWX and EWX, its unclear why they persist with the index that stipulates a $2B cap.

GWX
To be included in the Index, a publicly listed company must have a total market capitalization between $100 million and $2 billion, and be located in a country that meets the BMI Developed World Series criteria

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