Exchange traded funds are lauded for their tax efficiency, and as we head toward the end of 2013, only a fraction of fund products are expected to make capital gains distributions.
Most ETFs redeem securities “in-kind,” or swap securities for securities, unlike mutual funds, which typically redeem shares by selling securities. [In-Kind Creations and Redemptions]
However, the ETF redemption process does is not always perfectly executed, and at times, capital gains are not always eliminated entirely, writes Robert Goldsborough, fund analyst on the passive funds research team for Morningstar. Specifically, ETFs can have capital gains distributions if there is not enough trading activity in the underlying security, and some securities are not easily traded in-kind. [No Cap Gains on IndexIQ ETFs]
“However, capital gains are much less frequent for ETF investors than for mutual fund investors, and some ETFs can go years and years without making a capital gains distribution,” Goldsborough said.
As 2013 comes to a close, most providers have provided estimated capital gains distributions. Of the five largest ETF providers – iShares, Vanguard, State Street, PowerShares and Schwab – only 38 of 670 funds are facing capital gains distributions. [Scant 2013 Cap Gains Expected for PowerShares ETFs]
Specifically, iShares showed capital gains distributions on four of the firm’s 299 ETFs; PowerShares had distributions on seven of 159 ETFs; Vanguard saw distributions on eight of 67 ETFs; State Street included distributions on 19 of 124 ETFs; Schwab revealed distributions on none of its 21 ETFs. [Don’t Ask Chuck for 2013 ETF Cap Gains]
“And in almost every case, the distributions are very small–much less than 1% of the affected funds’ net asset value,” Goldsborough added.
Bond ETF investors should anticipate a higher frequency of capital gains distributions. Bond ETFs saw heavy outflows this year, which required more selling, and bond ETF managers typically see higher turnover rates.
The largest ETFs with capital gains distributions include the Vanguard Total Bond Market (NYSEArca: BND), iShares Core Total Aggregate US Bond (NYSEArca: AGG), Vanguard Short-Term Bond (NYSEArca: BSV), SPDR S&P Dividend (NYSEArca: SDY) and Vanguard Short-Term Corporate Bond Index (NYSEArca: VCSH).
The ETFs with the largest cap gains include SPDR Russell Small Cap Completeness (NYSEArca: RSCO), SPDR S&P Pharmaceuticals (NYSEArca: XPH), SPDR Nuveen Barclays CA Municipal Bond (NYSEArca: CXA), SPDR S&P Software & Services (NYSEArca: XSW) and SPDR Nuveen Barclays NY Muni Bond (NYSEArca: INY).
For more information on the ETF industry, visit our current affairs category.