Few ETFs that issue capital gains distributions are seen as an outlier. The ETF structure would usually negate any taxable events when diminishing or increasing holdings. Specifically, many passive ETFs inherently have low turnovers. More importantly, ETFs have to ability to redeem securities “in-kind” where fund operators can sidestep capital gains by swapping securities for other securities without incurring large capital gains. [ETFs & Mutual Funds: Lump of Capital Gains in Your Stockings]
In contrast, traditional mutual funds typically redeem securities by selling off a position for cash, triggering a taxable event. [Worried About Year-End Capital Gains Taxes? ETFs May Help]
For the most part, ETFs that issue capital gains distributions typically experience greater trading activity, use futures contracts, see a significant change up in its underlying index or track fixed-income securities.
Specifically, leveraged and inverse ETFs that use futures contracts can incur capital gains distributions. Moreover, currency-hedged equity ETFs may see capital gains distributions, with managers triggering gains by rolling currency futures and forward contracts hedges as the U.S. dollar strengthened this year.