Jason Zweig’s latest WSJ article on ETF/MF taxation

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Novice2020
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Jason Zweig’s latest WSJ article on ETF/MF taxation

Post by Novice2020 »

https://www.wsj.com/finance/investing/y ... 75?mod=mhp

If I am reading this correctly, it sounds like mutual funds may soon add ETF share classes, which could eliminate the tax advantage that ETF’s supposedly have now? Similar to what VTSAX has been doing with VTI for several years?

Is this overblown? I’ve been a happy FSKAX customer. Wondering what if any impact it will have.
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Re: Jason Zweig’s latest WSJ article on ETF/MF taxation

Post by nisiprius »

I can't read the paywalled article, but... Isn't it the other way around? VTSAX is highly tax-efficient because of having VTI as a share class?

In other words, this would be a good thing for mutual fund investors.

On checking, I see that VTSAX has not made any capital gains distributions in the last ten years, while FSKAX made them in 2018 and 2019.

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Re: Jason Zweig’s latest WSJ article on ETF/MF taxation

Post by Cocoa Beach Bum »

nisiprius wrote: Sun Feb 11, 2024 8:22 pm I can't read the paywalled article, but...
Try: Your Mutual Fund Stinks. Can This Wall Street Invention Change That?.

It appears author argues that active mutual funds might be able to hang on to investors if they're allowed to offer ETF share class.
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Re: Jason Zweig’s latest WSJ article on ETF/MF taxation

Post by Novice2020 »

nisiprius wrote: Sun Feb 11, 2024 8:22 pm I can't read the paywalled article, but... Isn't it the other way around? VTSAX is highly tax-efficient because of having VTI as a share class?

In other words, this would be a good thing for mutual fund investors.

On checking, I see that VTSAX has not made any capital gains distributions in the last ten years, while FSKAX made them in 2018 and 2019.

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Yes, it would seem to be a good thing for MF investors. I’m curious what most Bogleheads think though—I suspect some will think it’s a wash and overblown.
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Re: Jason Zweig’s latest WSJ article on ETF/MF taxation

Post by Halicar »

I don't understand this:

"If you own a faltering old mutual fund that’s stinking up your portfolio, you can sell it—but you might incur a stiff capital-gains tax bill. If that mutual fund had an ETF share class, you could exchange into it without triggering any tax."

But then you still own the undesirable fund, unless you can then sell the ETF shares without incurring a tax? That can't be true, can it?
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Re: Jason Zweig’s latest WSJ article on ETF/MF taxation

Post by billaster »

nisiprius wrote: Sun Feb 11, 2024 8:22 pm In other words, this would be a good thing for mutual fund investors.
Yeah, but the question you should always ask is how good.

For 2019 the capital gain was 0.15%. For a $100,000 investment that is $150 which is a tax of $23. 2018 was a little more, but then 2020, 2021, 2022 and 2023 were zero. This averages out to a few dollars a year.

Bogleheads are forever getting tied up in trivialities and futzing with their portfolios. This isn't exactly life changing.
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Re: Jason Zweig’s latest WSJ article on ETF/MF taxation

Post by Dirghatamas »

Halicar wrote: Sun Feb 11, 2024 8:56 pm I don't understand this:

"If you own a faltering old mutual fund that’s stinking up your portfolio, you can sell it—but you might incur a stiff capital-gains tax bill. If that mutual fund had an ETF share class, you could exchange into it without triggering any tax."

But then you still own the undesirable fund, unless you can then sell the ETF shares without incurring a tax? That can't be true, can it?
I read the article and while well-intentioned, it does seem to have several technical errors.

As you point out, simply buying the ETF version of an undesirable fund doesn't solve anything. Your cost basis is transferred, along with your date of purchase. Your capital gains remain the same. Your taxes can't magically disappear by converting from MF to ETF share class, otherwise it would be the biggest tax loophole discussed on Bogleheads :moneybag . The only argument I can think of is that the ETF version of this undesirable fund may have a lower ER due to lower overall costs. That seems like a minor point. Usually MF vs. ETF share classes have 1-2 basis point differences, not large ones. If you want to get out of bad actively managed MF..you would want out whether or not it was MF or ETF.

The article also incorrectly states
Investors may buy or sell either the mutual fund or the ETF share class at different times. They can freely exchange from one to the other without incurring fees or triggering taxes.
meaning MF or ETF share classes can be exchanged. This is NOT true at least at Vanguard so far. It is a one way street: you can go from MF to ETF but not the other way around. The article implies (in so many words) that one can exchange without fees or taxes both ways. That is NOT true so far.

The one useful thing I got out of the article was a link to the actual patent document by Sauter/Vanguard. That was a seriously cool innovation more than 20 years ago by VG.
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Re: Jason Zweig’s latest WSJ article on ETF/MF taxation

Post by tetractys »

I can’t believe it’s been 20 years already, and how quickly a patent can expire! Well it should be good for investors if they can convert their shares of a tax inefficient mutual fund to it’s more tax efficient a cheaper ETF class. But will it be the same as at Vanguard where the ETF share class also benefits the mutual fund classes?
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Re: Jason Zweig’s latest WSJ article on ETF/MF taxation

Post by retired@50 »

Dirghatamas wrote: Sun Feb 11, 2024 10:38 pm
As you point out, simply buying the ETF version of an undesirable fund doesn't solve anything. Your cost basis is transferred, along with your date of purchase. Your capital gains remain the same. Your taxes can't magically disappear by converting from MF to ETF share class, otherwise it would be the biggest tax loophole discussed on Bogleheads :moneybag .
I think what it "solves" is that if other investors in the fund head for the doors and cash out of the undesirable mutual fund, you won't be hit with a capital gains distribution (i.e. unwanted forced income) because the fund would be able to wash away those gains in the ETF share class. So, by holding the ETF share class you'd be protected from a race to the exits.

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Re: Jason Zweig’s latest WSJ article on ETF/MF taxation

Post by sc9182 »

ETFs being more portable - can take it to just about any shop. Can short, margin, and/or lending — lot easier (not that any of these are trivial things to consider). It helps - instead or needing to sell for very little need.

Afraid - there MF now has to make-do with “more expenses” to accommodate more “trading” happening under its sister-ETF ..

Dunno it helps long run - but it’s a decent feature nonetheless.
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Re: Jason Zweig’s latest WSJ article on ETF/MF taxation

Post by Nahtanoj »

Furthermore, if I understand this correctly, the ETF should be able to distribute low cost basis portfolio securities to authorized participants who are redeeming existing ETF shares, and acquire high cost basis portfolio securities from authorized participants who are delivering portfolio securities in exchange for newly issued ETF shares.

The net effect over time would be to increase the average cost basis of the portfolio securities that are held by the ETF and the associated mutual fund, thereby reducing the embedded capital gains in the portfolio of the ETF and associated mutual fund.
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Re: Jason Zweig’s latest WSJ article on ETF/MF taxation

Post by jeffyscott »

Halicar wrote: Sun Feb 11, 2024 8:56 pm I don't understand this:

"If you own a faltering old mutual fund that’s stinking up your portfolio, you can sell it—but you might incur a stiff capital-gains tax bill. If that mutual fund had an ETF share class, you could exchange into it without triggering any tax."

But then you still own the undesirable fund, unless you can then sell the ETF shares without incurring a tax? That can't be true, can it?
In context, I thought he was saying investors may be sorta tricked into staying in a crappy fund if their holdings can become a cool, new ETF.

There's this:
At underperforming active funds, it could entrap disgruntled investors and keep them from voting with their feet.
and
The vaunted advantages of ETFs could enable fund managers to entice investors to stick around even in cruddy portfolios.

It seems like a lot of the activity towards creating ETF share classes is aimed at active funds, rather than making index mutual funds even better.
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Re: Jason Zweig’s latest WSJ article on ETF/MF taxation

Post by Dirghatamas »

The ETF structure isn’t a cure-all, though. While it’s an unlikely scenario, Sauter notes that massive redemptions from an underperforming actively managed mutual fund in an up market could saddle investors in its ETF share class with capital-gains tax liabilities.
Gus Sauter is quoted in this article by Jason, briefly mentioning that embedded/unrealized capital gains in an ETF could still be a problem. Leaving aside active funds, I have on and off worried about VTI as a "black swan event" of redemptions. Some time back I converted my taxable Total stock market fund (institutional class) to the ETF class. At the time, the ER was the same between the two so no gain. The main reason was portability but a secondary reason (vaguely in my brain) was that ETF's are immune to this embedded gains issue.

Thinking again, if VTI is just a share class of the fund, its share of any redemption embedded gains must also be pro rated..so you can't gain. Looking around I found this article/video from Morningstar's Christine Benz which goes into this issue.

https://www.morningstar.com/etfs/should ... ard-etfs-2

Basically, ETFs have an advantage natively, but if you bolt an ETF on top of mutual funds (like VG has done), the ETF class has a higher risk (because of its mutual fund share class).

They (Morningstar video) say the risk is small, but I would still like to understand how it is even possible? If an ETF can create/redeem shares through in kind transfers to Authorized participants, why can it not remove ALL the embedded gains from a passive index fund like the Vanguard total stock market?

This might have sounded like a conspiracy theory in the past but the recent Vanguard fiasco around their taxable Target Date funds really did happen (and they have a class action lawsuit going on).

At present, according to VG, the Total Stock Index fund is sitting on ~51% embedded gains while newer funds like ITOT from blackrock will have an advantage being newer (so less embedded gains) and not having a sister MF. The total stock market index fund has ~1.5T in assets and VTI (its ETF share class) is $348 billion. So the ETF side is ~23% of the total fund. ~51% embedded gains on 1.5T ~0.75T $. So the embedded gains are much larger than the total assets in VTI :shock: :shock:

If the embedded gains are much larger than the total assets in the ETF share class (750 billion vs. 348 billion), how would in kind redemptions work in erasing that gain..?
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Re: Jason Zweig’s latest WSJ article on ETF/MF taxation

Post by alex_686 »

Dirghatamas wrote: Wed Feb 14, 2024 2:57 pm They (Morningstar video) say the risk is small, but I would still like to understand how it is even possible? If an ETF can create/redeem shares through in kind transfers to Authorized participants, why can it not remove ALL the embedded gains from a passive index fund like the Vanguard total stock market?

This might have sounded like a conspiracy theory in the past but the recent Vanguard fiasco around their taxable Target Date funds really did happen (and they have a class action lawsuit going on).
There are two issues here.

Why can’t a fund remove all capital gains via in-kind redemptions? Well, if there is a mass exodus from the mutual fund side then the fund would have to use a traditional trading desk to sell securities in a traditional fashion that would trigger capital gains. Or there could be a liquidity event. Chances are small but they do happen. See the target date fund.

There is another issue that hasn’t been mentioned. Mutual fund trading is costlier than ETF. It isn’t part of the expense ratio. Most of the cost is implicit. So it is nuanced and a bit of guesswork.
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Re: Jason Zweig’s latest WSJ article on ETF/MF taxation

Post by Cocoa Beach Bum »

Dirghatamas wrote: Wed Feb 14, 2024 2:57 pm...
At present, according to VG, the Total Stock Index fund is sitting on ~51% embedded gains while newer funds like ITOT from blackrock will have an advantage being newer (so less embedded gains) and not having a sister MF. The total stock market index fund has ~1.5T in assets and VTI (its ETF share class) is $348 billion. So the ETF side is ~23% of the total fund. ~51% embedded gains on 1.5T ~0.75T $. So the embedded gains are much larger than the total assets in VTI :shock: :shock:

If the embedded gains are much larger than the total assets in the ETF share class (750 billion vs. 348 billion), how would in kind redemptions work in erasing that gain..?
Pretty soon you'll be talking real money, the kind that attacks scrutiny from legislators desperate to balance their spending jags with new taxes.
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Re: Jason Zweig’s latest WSJ article on ETF/MF taxation

Post by Lyrrad »

Novice2020 wrote: Sun Feb 11, 2024 8:18 pm https://www.wsj.com/finance/investing/y ... 75?mod=mhp

If I am reading this correctly, it sounds like mutual funds may soon add ETF share classes, which could eliminate the tax advantage that ETF’s supposedly have now? Similar to what VTSAX has been doing with VTI for several years?

Is this overblown? I’ve been a happy FSKAX customer. Wondering what if any impact it will have.
It's unclear.

The article states that no SEC decisions are expected this year.

There have been other articles suggesting that the SEC was reluctant to approve new dual-class ETF/mutual funds. Vanguard licensed out their patent(s) while it was active, but no competitors got any approved. I recall hearing that even Vanguard had trouble getting new dual-class funds approved in recent years. Perhaps whatever objections there were will be overcome.

If that happens, I'd expect it to improve competition, so it would hopefully be better for investors.
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Re: Jason Zweig’s latest WSJ article on ETF/MF taxation

Post by billaster »

alex_686 wrote: Wed Feb 14, 2024 3:14 pm There is another issue that hasn’t been mentioned. Mutual fund trading is costlier than ETF. It isn’t part of the expense ratio. Most of the cost is implicit.
There is no evidence for mutual fund trading being costlier than ETF trading. In fact, what evidence there is says that ETF trading is costlier. Which shouldn't be any surprise. The ETF inserts a third party trader between the mutual fund and the market makers. Those third party traders don't work for free.
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Re: Jason Zweig’s latest WSJ article on ETF/MF taxation

Post by Dirghatamas »

alex_686 wrote: Wed Feb 14, 2024 3:14 pm There are two issues here.

Why can’t a fund remove all capital gains via in-kind redemptions? Well, if there is a mass exodus from the mutual fund side then the fund would have to use a traditional trading desk to sell securities in a traditional fashion that would trigger capital gains. Or there could be a liquidity event. Chances are small but they do happen. See the target date fund.
Alex I know you worked inside funds so may have a more detailed view of how the numbers could work. As a naive outsider, when I dug through the numbers (size of VTI vs. overall Total Index, size of embedded gains) it does make me nervous. I was surprised how small is VTI compared to its mutual fund parent (just 23% of total) and also by the sheer size and % of embedded gains. There are $750 Billions of embedded gains in that fund! That's a staggering amount. I don't have data on how much of the parent is in taxable vs. tax deferred/tax free. For the latter two, these gains are not an issue. If the bulk of the 750 billion in embedded gains only has VTI as its escape valve by creation/redemption through authorized participants, then this feels like a ticking time bomb.

The only good news is that the numbers are so large that VG can't possibly make a mistake by accident. In the case of the TDF fiasco, perhaps they genuinely didn't understand the full impact of their decisions. That can't possibly happen here. US Govt would probably get involved right away given these trillion dollar numbers.
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Re: Jason Zweig’s latest WSJ article on ETF/MF taxation

Post by sycamore »

Dirghatamas wrote: Wed Feb 14, 2024 2:57 pm They (Morningstar video) say the risk is small, but I would still like to understand how it is even possible? If an ETF can create/redeem shares through in kind transfers to Authorized participants, why can it not remove ALL the embedded gains from a passive index fund like the Vanguard total stock market?
Remember that just because an ETF "can" do that doesn't mean the opportunity will always be there. It requires willing participants on the other side of the table.

Witness Vanguard International Dividend Appreciation Index fund. Vanguard changed the underlying index in 2021, and ended up distributing non-trivial short-term and long-term capital gains (~6% total) even though there was an ETF share class. See 2021 on https://advisors.vanguard.com/investmen ... tributions

Morningstar had this to say:
https://www.morningstar.com/etfs/etfs-proved-their-tax-advantages-are-still-strong-2021 wrote:This marks the fund’s first-ever such distribution since its 2016 inception. VIGI’s distribution is the result of above-normal turnover (partly spurred by post-pandemic dividend cuts among some of its holdings), the inability to send some emerging-markets stocks out the door via in-kind redemptions, and strong one-directional flows. When ETFs experience strong inflows and few if any redemptions, they have fewer natural opportunities to rid low-cost-basis securities from their portfolios.
Personally I think that was a one-off occurrence and don't expect it to happen with the usual Boglehead broad-based stock market funds.
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Re: Jason Zweig’s latest WSJ article on ETF/MF taxation

Post by billaster »

Cathie Wood's ETF ARKK has distributed long and short term gains of more than 3%. These are probably the result of substantial rebalancing operations. Seems to indicate that not all capital gains can easily be flushed away if you are moving enough money.
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Re: Jason Zweig’s latest WSJ article on ETF/MF taxation

Post by LilyFleur »

One bit of good news here: Jason Zweig is back writing for the WSJ again.
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Re: Jason Zweig’s latest WSJ article on ETF/MF taxation

Post by Cocoa Beach Bum »

LilyFleur wrote: Wed Feb 14, 2024 8:42 pm One bit of good news here: Jason Zweig is back writing for the WSJ again.
Agreed. According to the Jan 26, 2024 WSJ article archived here, he had been away about 8 months on "book leave."
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Re: Jason Zweig’s latest WSJ article on ETF/MF taxation

Post by Northern Flicker »

Halicar wrote: Sun Feb 11, 2024 8:56 pm I don't understand this:

"If you own a faltering old mutual fund that’s stinking up your portfolio, you can sell it—but you might incur a stiff capital-gains tax bill. If that mutual fund had an ETF share class, you could exchange into it without triggering any tax."
You should not need to convert shares to ETF shares to get the tax benefit if the product is implemented correctly.
Last edited by Northern Flicker on Thu Feb 15, 2024 12:51 pm, edited 1 time in total.
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Re: Jason Zweig’s latest WSJ article on ETF/MF taxation

Post by livesoft »

I'd like a product where all capital gains created by the managers selling winners are attributed to the shares held in the Roth accounts of customers and the capital losses created by the managers are attributed to the shares held in the taxable accounts of customers.
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Re: Jason Zweig’s latest WSJ article on ETF/MF taxation

Post by asset_chaos »

livesoft wrote: Thu Feb 15, 2024 12:25 am I'd like a product where all capital gains created by the managers selling winners are attributed to the shares held in the Roth accounts of customers and the capital losses created by the managers are attributed to the shares held in the taxable accounts of customers.
zippity do dah, now we're talking!
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Re: Jason Zweig’s latest WSJ article on ETF/MF taxation

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livesoft wrote: Thu Feb 15, 2024 12:25 am I'd like a product where all capital gains created by the managers selling winners are attributed to the shares held in the Roth accounts of customers and the capital losses created by the managers are attributed to the shares held in the taxable accounts of customers.
Me too. Do you think you could ever get the IRS to go for this idea?

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