Vanguard ETFs are less tax efficient than others

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burritoLover
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Vanguard ETFs are less tax efficient than others

Post by burritoLover »

I listened to the podcast below and these two points were mentioned that made no sense to me:

1. That Vanguard ETFs are not as tax efficient as other ETFs because Vanguard uses some process they patented that makes their ETFs more mutual-fund like. Now, I've heard of them having a patented process to make their mutual funds more tax efficient but not that this had anything to do with ETFs.

2. Vanguard has the option to distribute to you the fractional shares of all the securities in a fund when you sell shares of the fund forcing you to liquidate all these individual stock positions yourself. Made it sound like it was in your agreement with Vanguard that they could use this option if they wanted to.

Tax Efficiencies of ETFs vs. Mutual Funds: EDU #2117
The Retirement and IRA Show
https://podcasts.apple.com/us/podcast/t ... 0518960805
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sycamore
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Re: Vanguard ETFs are less tax efficient than others

Post by sycamore »

This is not a new concern. Here's an article from 2004 when Vanguard's ETF were called VIPERs that discusses the same thing: https://www.morningstar.com/articles/10 ... ers-flawed.

There are some previous BH threads about it too.

In practice, the concerns about the patented ETF/mutual-fund structure have not actually caused any tax-inefficiency.
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Re: Vanguard ETFs are less tax efficient than others

Post by UpperNwGuy »

I keep reading that Vanguard's VTSAX is the most tax efficient of the Total US Stock Market mutual funds, but I also read that BlackRock's ITOT ETF is more tax efficient than VTI (the ETF share class of VTSAX).
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Re: Vanguard ETFs are less tax efficient than others

Post by burritoLover »

sycamore wrote: Mon May 03, 2021 6:34 pm This is not a new concern. Here's an article from 2004 when Vanguard's ETF were called VIPERs that discusses the same thing: https://www.morningstar.com/articles/10 ... ers-flawed.

There are some previous BH threads about it too.

In practice, the concerns about the patented ETF/mutual-fund structure have not actually caused any tax-inefficiency.
Ah, found a newer article for Morningstar about this. Sounds legit (on #1):
https://www.morningstar.com/articles/85 ... guard-etfs
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Re: Vanguard ETFs are less tax efficient than others

Post by alex_686 »

1. Is probably off. It would take horribly mismanagement by Vanguard in regards to a mass exodus of funds from the mutual fund side.

2. I can’t even comprehend this point. Maybe this in regards to the redemption process by the AP? There is some boilerplate language in all ETFs allowing something like this in regards to the AP.
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Re: Vanguard ETFs are less tax efficient than others

Post by Cheez-It Guy »

Better sell it all immediately!
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Re: Vanguard ETFs are less tax efficient than others

Post by retired@50 »

Seems like someone is trying to scare Vanguard index fund and ETF investors for no good reason.

While possible in a mass redemption event, not likely at all.

Then again, I don't worry about getting hit by a meteor either.

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Re: Vanguard ETFs are less tax efficient than others

Post by nisiprius »

burritoLover wrote: Mon May 03, 2021 6:23 pm...2. Vanguard has the option to distribute to you the fractional shares of all the securities in a fund when you sell shares of the fund forcing you to liquidate all these individual stock positions yourself. Made it sound like it was in your agreement with Vanguard that they could use this option if they wanted to...
That's ridiculous FUD (fear, uncertainty, and doubt).

I am 99% certain that all mutual funds give the issuer the option of "redemption in kind," but it would only be used in extraordinary circumstances--involving gigantic institutional redemptions, of funds that are invested in insufficiently liquid assets.

Here is the language from the prospectus for the Fidelity Total Market Index Fund, FSKAX:
Redemption proceeds may be paid in securities or other property rather than in cash if the Adviser determines it is in the best interests of a fund.
As for ETFs, ETFs always use "redemption in kind," it's the only way an ETF can be redeemed--but it doesn't matter because only the "authorized participants" can redeem them. You, the investor, "redeem" a mutual fund, but you don't "redeem" an ETF, you sell it to another investor.

Reality check: etfdb says
For ETFs, in-kind redemptions are the primary mechanism by which redemptions are made. When an investor wants to redeem ETF shares, the distributor usually exchanges the shares to be redeemed for a basket of securities held by the ETF. Only “authorized participants” – a form of institutional investor – may redeem shares directly from an ETF. These investors are also able to contribute securities to a fund in exchange for newly issued ETF shares. Retail investors, on the other hand, can only buy and sell ETF shares through a broker.
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Re: Vanguard ETFs are less tax efficient than others

Post by Dave55 »

UpperNwGuy wrote: Mon May 03, 2021 6:38 pm I keep reading that Vanguard's VTSAX is the most tax efficient of the Total US Stock Market mutual funds, but I also read that BlackRock's ITOT ETF is more tax efficient than VTI (the ETF share class of VTSAX).
Looking at the tax cost ratio on Fidelity, VTI Tax cost ratio is .38% and ITOT tax cost ratio is .65%.
Looks like VTI is .27% less tax drag than ITOT.

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Re: Vanguard ETFs are less tax efficient than others

Post by Doc »

My understanding.

When an ETF redeems shares it chooses which shares to redeem based on tax efficiency. Because Vg's ETFs are a share class of the corresponding mutual fund that advantage gets diluted.
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Re: Vanguard ETFs are less tax efficient than others

Post by RubyTuesday »

Having the mutual fund issuer let (force?) an investor to redeem in kind could be advantageous in certain instances. IIRC large investors have asked for this in some cases, presumably to manage taxes.
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Re: Vanguard ETFs are less tax efficient than others

Post by RubyTuesday »

RubyTuesday wrote: Mon May 03, 2021 8:13 pm Having the mutual fund issuer let (force?) an investor to redeem in kind could be advantageous in certain instances. IIRC large investors have asked for this in some cases, presumably to manage taxes.
And if cash redemptions exceed cash inflows from new investments, redeeming in kind would actually be good for all the remaining fund holders who would otherwise potentially be forced to realize a gain.

It’s exactly how you would want a fund structured I think.
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Re: Vanguard ETFs are less tax efficient than others

Post by assyadh »

Yes Vanguard is less tax efficient than Blackrock on some products (IXUS vs VXUS for instance). See viewtopic.php?t=206546

triceratop releases an annual comparison: https://docs.google.com/spreadsheets/d/ ... edit#gid=0

This data for 2017, showed that VTI vs ITOT was a wash,but IXUS was 0.20% cheaper a year to hold.
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Re: Vanguard ETFs are less tax efficient than others

Post by sycamore »

assyadh wrote: Mon May 03, 2021 8:28 pm Yes Vanguard is less tax efficient than Blackrock on some products (IXUS vs VXUS for instance). See viewtopic.php?t=206546

triceratop releases an annual comparison: https://docs.google.com/spreadsheets/d/ ... edit#gid=0

This data for 2017, showed that VTI vs ITOT was a wash,but IXUS was 0.20% cheaper a year to hold.
For the 2020 version, see viewtopic.php?t=342995
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Re: Vanguard ETFs are less tax efficient than others

Post by assyadh »

sycamore wrote: Mon May 03, 2021 8:59 pm
assyadh wrote: Mon May 03, 2021 8:28 pm Yes Vanguard is less tax efficient than Blackrock on some products (IXUS vs VXUS for instance). See viewtopic.php?t=206546

triceratop releases an annual comparison: https://docs.google.com/spreadsheets/d/ ... edit#gid=0

This data for 2017, showed that VTI vs ITOT was a wash,but IXUS was 0.20% cheaper a year to hold.
For the 2020 version, see viewtopic.php?t=342995
Thanks. So ITOT wins by 0.01% ER (negligable) but IXUS is still a clear winner against VXUS
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Re: Vanguard ETFs are less tax efficient than others

Post by stan1 »

assyadh wrote: Mon May 03, 2021 9:38 pm
sycamore wrote: Mon May 03, 2021 8:59 pm
assyadh wrote: Mon May 03, 2021 8:28 pm Yes Vanguard is less tax efficient than Blackrock on some products (IXUS vs VXUS for instance). See viewtopic.php?t=206546

triceratop releases an annual comparison: https://docs.google.com/spreadsheets/d/ ... edit#gid=0

This data for 2017, showed that VTI vs ITOT was a wash,but IXUS was 0.20% cheaper a year to hold.
For the 2020 version, see viewtopic.php?t=342995
Thanks. So ITOT wins by 0.01% ER (negligable) but IXUS is still a clear winner against VXUS
That was last year. It could change this year and next year and the year after that. I would not worry about that type of optimization and in a taxable account you will buy and hold for potentially decades to defer realizing capital gains. Even if someone comes up with a reason IXUS is a little more tax efficient than VXUS justified by something in the respective index construction the index construction methodology could still change. If you tax loss harvest you will likely end up owning both IXUS and VXUS anyways. I'd be happy with either VXUS or IXUS (and hold both right now, more VXUS because that's what I bought last Spring 2020 when I tax loss harvested a lot of IXUS).
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Re: Vanguard ETFs are less tax efficient than others

Post by WoodSpinner »

burritoLover wrote: Mon May 03, 2021 6:23 pm I listened to the podcast below and these two points were mentioned that made no sense to me:

1. That Vanguard ETFs are not as tax efficient as other ETFs because Vanguard uses some process they patented that makes their ETFs more mutual-fund like. Now, I've heard of them having a patented process to make their mutual funds more tax efficient but not that this had anything to do with ETFs.

2. Vanguard has the option to distribute to you the fractional shares of all the securities in a fund when you sell shares of the fund forcing you to liquidate all these individual stock positions yourself. Made it sound like it was in your agreement with Vanguard that they could use this option if they wanted to.

Tax Efficiencies of ETFs vs. Mutual Funds: EDU #2117
The Retirement and IRA Show
https://podcasts.apple.com/us/podcast/t ... 0518960805
FWIW, this was not their best Podcast. I don’t think Jim explained it very well.

Truth is that an ETF by design is more efficient than the equivalent Mutual fund since redemptions can occur in-kind thus avoiding Capital Gains. Thtat said, Vanguard Mutual Funds are as efficient as their ETF equivalents due to their patent allowing the MF to take advantage of the ETF redemption process.

I wanted to slap Jim a few times for how he convoluted what should have been a simple clear explanation.

That said, I am an avid listener ...

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Re: Vanguard ETFs are less tax efficient than others

Post by Northern Flicker »

Doc wrote: Mon May 03, 2021 7:31 pm My understanding.

When an ETF redeems shares it chooses which shares to redeem based on tax efficiency. Because Vg's ETFs are a share class of the corresponding mutual fund that advantage gets diluted.
This is offset by the fact that Vanguard can use the lowest cost basis shares from the mutual fund class when spinning up new ETF shares, an advantage other ETF providers lack.

I did not see any mention of heartbeat trades in the articles referenced above. These are so quintessential to how ETF's achieve tax efficiency that any analysis is suspect if it fails to consider them.

Have any Vanguard ETFs ever distributed a capital gain?
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Re: Vanguard ETFs are less tax efficient than others

Post by Northern Flicker »

Percentage of dividends that are qualified and, for non-US ETFs, foreign taxes and their credits are generally what distinguishes tax efficiency of ETFs.

VTI has generally been more tax efficient than ITOT, but iShares int'l index ETFs have generally been more tax-efficient than their Vanguard counterparts.
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Re: Vanguard ETFs are less tax efficient than others

Post by okwriter »

burritoLover wrote: Mon May 03, 2021 6:43 pm
sycamore wrote: Mon May 03, 2021 6:34 pm This is not a new concern. Here's an article from 2004 when Vanguard's ETF were called VIPERs that discusses the same thing: https://www.morningstar.com/articles/10 ... ers-flawed.

There are some previous BH threads about it too.

In practice, the concerns about the patented ETF/mutual-fund structure have not actually caused any tax-inefficiency.
Ah, found a newer article for Morningstar about this. Sounds legit (on #1):
https://www.morningstar.com/articles/85 ... guard-etfs
Here’s an even more recent article (2020) from the same author: https://www.morningstar.com/articles/96 ... -tax-risks

He says the risk has diminished because Vanguard's ETFs have been growing faster than its mutual funds.
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Re: Vanguard ETFs are less tax efficient than others

Post by Doc »

Northern Flicker wrote: Mon May 03, 2021 10:06 pm
Doc wrote: Mon May 03, 2021 7:31 pm My understanding.

When an ETF redeems shares it chooses which shares to redeem based on tax efficiency. Because Vg's ETFs are a share class of the corresponding mutual fund that advantage gets diluted.
This is offset by the fact that Vanguard can use the lowest cost basis shares from the mutual fund class when spinning up new ETF shares, an advantage other ETF providers lack.
I don't see how it can buy shares from itself unless the new ETF shares match redemptions from the mutual fund share class. And in that case it's a net zero since they share the tax whether it's a gain or loss. ???
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Re: Vanguard ETFs are less tax efficient than others

Post by Northern Flicker »

They don't have the fund buy shares from itself. When they create new ETF shares they can map the lowest basis shares in the fund to the new ETF shares.
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Re: Vanguard ETFs are less tax efficient than others

Post by Northern Flicker »

Answering my earlier question, Vanguard bond index ETFs have at times distributed capital gains. That is also true of iShares bond ETFs.
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Re: Vanguard ETFs are less tax efficient than others

Post by Thesaints »

Google "vanguard", "etf", and "heartbeat".
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Re: Vanguard ETFs are less tax efficient than others

Post by Angst »

Thesaints wrote: Tue May 04, 2021 1:08 pm Google "vanguard", "etf", and "heartbeat".
+1
https://www.investopedia.com/how-heartb ... ns-4684138
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Re: Vanguard ETFs are less tax efficient than others

Post by grabiner »

Dave55 wrote: Mon May 03, 2021 7:18 pm
UpperNwGuy wrote: Mon May 03, 2021 6:38 pm I keep reading that Vanguard's VTSAX is the most tax efficient of the Total US Stock Market mutual funds, but I also read that BlackRock's ITOT ETF is more tax efficient than VTI (the ETF share class of VTSAX).
Looking at the tax cost ratio on Fidelity, VTI Tax cost ratio is .38% and ITOT tax cost ratio is .65%.
Looks like VTI is .27% less tax drag than ITOT.
Fidelity is getting its numbers from Morningstar, which doesn't always know about qualified dividends. The actual tax costs of these two ETFs should be almost equal, as they track similar indexes and have almost all their dividends qualified.
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Re: Vanguard ETFs are less tax efficient than others

Post by grabiner »

burritoLover wrote: Mon May 03, 2021 6:23 pm I listened to the podcast below and these two points were mentioned that made no sense to me:

1. That Vanguard ETFs are not as tax efficient as other ETFs because Vanguard uses some process they patented that makes their ETFs more mutual-fund like. Now, I've heard of them having a patented process to make their mutual funds more tax efficient but not that this had anything to do with ETFs.
This could be true in theory. Since the ETF and mutual fund are share classes of the same fund, creations and redemptions of the ETF have their tax benefits spread over the full fund balance.

But it hasn't been true in practice. Vanguard REIT Index is the only Vanguard stock ETF to have distributed a capital gain since 2010. (Vanguard FTSE All-World Ex-US Small-Cap Index, which started near the 2009 market bottom, distributed gains in 2009 and 2010, but is not likely to do so again.)
2. Vanguard has the option to distribute to you the fractional shares of all the securities in a fund when you sell shares of the fund forcing you to liquidate all these individual stock positions yourself. Made it sound like it was in your agreement with Vanguard that they could use this option if they wanted to.
While this is allowed, it is likely to happen only with institutional-size redemptions; Vanguard isn't going to give you $10K worth of hundreds of stocks. The only time I am aware that Vanguard did this was for Tax-Managed Small-Cap; it gave away stock in kind in order to avoid selling the stock for a capital gain.
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Re: Vanguard ETFs are less tax efficient than others

Post by Northern Flicker »

I think a fund retains the option to process withdrawals in-kind to cover a situation of great duress where the stocks held are illiquid, and a customer asks for a withdrawal. "Here. It's your problem now."
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Re: Vanguard ETFs are less tax efficient than others

Post by Doc »

Northern Flicker wrote: Wed May 05, 2021 7:58 pm I think a fund retains the option to process withdrawals in-kind to cover a situation of great duress where the stocks held are illiquid, and a customer asks for a withdrawal. "Here. It's your problem now."
I don't get it but there is more info here:

What Is an In-Kind Redemption for ETFs? https://etfdb.com/etf-education/what-is ... 0the%20ETF.

"New investors often envision receiving big cash payouts when they sell their securities at a profit. But what happens when the fund you are withdrawing from isn’t enjoying net inflows of capital?

This isn’t something most new investors think about when buying mutual funds or exchange-traded funds (ETFs). However, this scenario is extremely common and the process for addressing it is usually spelled out in the fund’s prospectus."

Perhaps it's the "big cash payouts"?
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Re: Vanguard ETFs are less tax efficient than others

Post by Northern Flicker »

If there is insufficient liquidity to generate the level of cash needed to process withdrawals, the fund manager has the option to distribute fund assets in-kind. Their illiquidity then becomes the fund investor's problem. The most likely time this might happen is a time of great financial duress when liquidity in markets has vanished. ETFs of course reduce this need because most ETF owners cannot redeem shares. I think it could still come into play if a fund is shutting down.
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Re: Vanguard ETFs are less tax efficient than others

Post by Crustus »

Northern Flicker wrote: Mon May 03, 2021 10:06 pm
Doc wrote: Mon May 03, 2021 7:31 pm My understanding.

When an ETF redeems shares it chooses which shares to redeem based on tax efficiency. Because Vg's ETFs are a share class of the corresponding mutual fund that advantage gets diluted.
This is offset by the fact that Vanguard can use the lowest cost basis shares from the mutual fund class when spinning up new ETF shares, an advantage other ETF providers lack.

I did not see any mention of heartbeat trades in the articles referenced above. These are so quintessential to how ETF's achieve tax efficiency that any analysis is suspect if it fails to consider them.

Have any Vanguard ETFs ever distributed a capital gain?
Yes, they have. I have a couple bond ETFs (Intermediate Corporate Bond - VCIT, and Intermediate Bond - BIV) that have distributed long and short term capital gains. Last December and the end of March this year. I haven't received any from the stock ETFs. I suspect this long runup has some of the funds running out of compensating losses.
And . . .
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Re: Vanguard ETFs are less tax efficient than others

Post by Doc »

Northern Flicker wrote: Fri May 07, 2021 12:54 am If there is insufficient liquidity to generate the level of cash needed to process withdrawals, the fund manager has the option to distribute fund assets in-kind. Their illiquidity then becomes the fund investor's problem. The most likely time this might happen is a time of great financial duress when liquidity in markets has vanished. ETFs of course reduce this need because most ETF owners cannot redeem shares. I think it could still come into play if a fund is shutting down.

Authorized participants (APs) are one of the major parties at the center of the ETF creation/redemption mechanism, and as such, they play a critical role in ETF liquidity.

In essence, APs are ETF liquidity providers that have the exclusive right to change the supply of ETF shares on the market. When they spot a shortage of ETF shares in the market, they create more shares. Conversely, when there’s an excess supply of ETF shares on the market, they reduce the number of shares by way of the creation and redemption mechanism.
https://www.etf.com/etf-education-cente ... rticipants

Goggle "authorized participant" to see many more sources.
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Re: Vanguard ETFs are less tax efficient than others

Post by Northern Flicker »

Redemptions and contributions by AP's is just the normal way ETF liquidity is maintained.
My postings are my opinion, and never should be construed as a recommendation to buy, sell, or hold any particular investment.
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