Exchange traded funds have been lauded for their efficiency and tax benefits but that there are still some exceptions to the rule.
ETFs are typically seen as more tax efficient than mutual funds due to their structure. Mutual fund managers may buy or sell components to take a profit or meet redemptions from shareholders, which triggers a taxable event. On the other hand, ETFs exchange baskets of securities for ETF shares in so-called in-kind creation/redemption transactions, which do not trigger a taxable event. However, this does not mean that ETF investors should not perform their due diligence. [Why Many Enjoy Tax Benefits of the ETF Structure]
“Not all ETFs have the same tax consequences,” Todd Rosenbluth, Director of ETF Research at S&P Capital IQ, said in a research note.
For instance, Rosenbluth singled out ETFs that are tied to fixed-income assets and currency-hedged equities.
Many fixed-income indices are rebalanced on a monthly basis, and a bond ETF index would carefully managed the numerous market changes including cash flows from coupon payments, new bond issues and bonds that have been called or paid down early. Consequently, bond ETFs that try to reflect a benchmark index tend to have higher turnover rates than stock ETFs.
For instance, the Vanguard Intermediate-term Bond ETF (NYSEArca: BIV) has a 60% turnover rate, whereas the Vanguard 500 Index (NYSEArca: VOO) has a turnover rate of just 3%. Nevertheless, the turnover rate is still below the Lipper large-cap core mutual fund average of 70%.
Due to BIV’s higher turnover rates, investors may incur capital gains.