Vanguard ETFs - diluted tax efficiency?

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Vanguard ETFs - diluted tax efficiency?

by boggler » Fri Jul 05, 2013 1:25 pm

From http://www.altruistfa.com/etfs.htm:

ETFs may be somewhat more tax efficient than similar conventional index mutual funds. This increased tax-efficiency is in the form of lesser capital gains distributions (which effectively means that an ETF's capital gains tend to be more deferred than a similar mutual fund's would be). The idea that ETFs should have lower capital gains distributions comes from their ability to shed their lowest-basis shares to institutional arbitrageurs through in-kind redemptions. Note that this benefit applies to a much lesser extent to Vanguard's ETFs. Because they exist as a separate share class of conventional mutual funds, any tax benefit a Vanguard ETF generates is shared by investors in the fund's non-ETF shares, thus diluting the beneficial effect for Vanguard ETF share owners.

Is this something to worry about?

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Re: Vanguard ETFs - diluted tax efficiency?

by boggler » Fri Jul 05, 2013 1:33 pm

And here's another concern from the same page.

ETFs may not be as tax efficient as you'd like. At present, qualifying dividend distributions from stocks are taxed at a preferentially low tax rate in the United States. One of the requirements to qualify for this low rate is that the stock has been held for at least 60 days. Due to share creation activity, this standard may not be met all the time. Thus, a portion of the dividend income received (and distributed) by the ETF may not qualify for the preferentially low tax rate for qualifying dividends.

Conventional index mutual funds have more control over this than do ETFs, and are therefore more likely to have a higher percentage of their distributed dividends qualify for the preferentially low tax rate.

Never heard of this. Is this valid?

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Re: Vanguard ETFs - diluted tax efficiency?

by livesoft » Fri Jul 05, 2013 1:33 pm

Nope.

This information has been prepared without taking into account the Sequestration, investment objectives, financial situation and particular needs of any particular person or company.

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Re: Vanguard ETFs - diluted tax efficiency?

by boggler » Fri Jul 05, 2013 2:57 pm

livesoft wrote:Nope.

Care to elaborate?

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Re: Vanguard ETFs - diluted tax efficiency?

by Majormajor78 » Sat Jul 06, 2013 1:29 am

boggler wrote:From http://www.altruistfa.com/etfs.htm:

ETFs may be somewhat more tax efficient than similar conventional index mutual funds. This increased tax-efficiency is in the form of lesser capital gains distributions (which effectively means that an ETF's capital gains tend to be more deferred than a similar mutual fund's would be). The idea that ETFs should have lower capital gains distributions comes from their ability to shed their lowest-basis shares to institutional arbitrageurs through in-kind redemptions. Note that this benefit applies to a much lesser extent to Vanguard's ETFs. Because they exist as a separate share class of conventional mutual funds, any tax benefit a Vanguard ETF generates is shared by investors in the fund's non-ETF shares, thus diluting the beneficial effect for Vanguard ETF share owners.

Is this something to worry about?

I've heard of this referenced to as the reason why Vanguard pays out less capital gains distributions than it used to. My understanding is that both the ETF owners and mutual fund owners share the benefits of managing the cost basis of the stocks held by the fund. I suppose it is logical for a pure ETF fund to have the potential to take advantage of this more fully but I don't think that is often the case. Market makers and institutional investors most actively arbitrage those ETF's that have sufficiently high volumes so that they can capitalize on any premium or discounts that develop.

For this reason, the funds that could potentially reap the tax benefit of managing their cost basis are the ETF behemoths like Blackrock and Vanguard. I don't believe the majority of boutique ETF's with smaller volumes and fewer arbitrage opportunities will reap the benefit as much as Vanguard. Perhaps Schwab can manage to have both a lower ER and be slightly more tax efficient... I just don't know. I understand the concept but is takes years of data and statistical analysis to declare one superior.

"Oh, M. le Comte, it is only a loss of money which I have sustained... nothing worth mentioning, I assure you."

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