Complete Guide To 2011 ETF Cap Gain Payouts
December 29, 2011
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(The following story has been updated to reflect updated information from a number of fund sponsors. We will continue to update the story as we collect definitive information from different firms, notably ETF Securities, United States Commodity Funds and RevenueShares.)
Only 103 of the 1,370 ETFs trading in the United States are paying capital gains distributions this year, according to a comprehensive survey of ETF providers conducted by IndexUniverse. The numbers include 202 exchange-traded notes, which are included within the broader ETF universe under the IndexUniverse ETF Classification System.
The low payout ratio—just 7.5 percent of the broader universe—is a clear reaffirmation of the tax efficiency of ETFs.
The record for ETFs wasn't perfect, however, and varied by asset category.
The most impressive performance came in traditional equity ETFs, where just 20 of 756 ETFs paid distributions. These payouts, however, included the fund with one the bigger distributions by any index equity ETF this year: the 7.02 percent payout by the Market Vectors − Brazil Small Cap ETF (NYSEArca: BRF).
The largest equity distributions went to the actively managed Columbia Concentrated Large Cap Value Strategy Fund (NYSEArca: GVT), which totaled 10.74 percent of the fund’s net asset value at the end of 2010. That’s not a huge surprise since portfolio turnover on active funds is usually much greater than on index funds.
Fixed income, however, fared far worse. Thirty-seven of 160 fixed-income ETFs paid out distributions, or nearly 24 percent of all nonleveraged ETFs. The payouts were small—31 of 37 funds paid out gains totaling less than 1 percent of each of the fund's net asset value. Nonetheless, the number of payouts was high.
Leveraged and inverse ETFs also saw significant distributions, with 15 of 259 geared ETFs on the market paying out distributions, or about 8 percent of all products.
Alternative ETFs—an asset category that includes hedge fund replication, long/short ETFs and similar strategies—had 10 of 49 ETFs paying distributions, or 20 percent of those funds.
Currency ETFs and asset allocation ETFs, however, weren't quite perfect, with six currency fund payouts among a combined 51 ETFs.
ETFs are known for being tax efficient for two primary reasons. First, the vast majority of ETFs are index funds, which have low turnover and therefore tend to be more tax efficient than mutual funds. Second, the in-kind creation and redemption mechanism at the center of every ETF allows most ETFs to continually cleanse their portfolios of positions with embedded capital gains.
ETNs are uniquely advantaged when it comes to capital gains, as due to their note structure, they don't make capital gains distributions. ETNs make up approximately 15 percent of all U.S.-listed exchange-traded products, across all asset classes. If you exclude ETNs, there were 97 payouts from 1,168 true exchange-traded funds, or just over 8 percent of all actual ETFs.
Bond Fund Payouts In Focus
The payouts in bond funds gained particular attention this year.
Of note, all the capital gains distributions reported by the three-biggest U.S. ETF sponsors—iShares, State Street Global Advisors and Vanguard Group—were in fixed-income ETFs. Bond funds face various challenges in terms of tax efficiency. For starters, unlike equity ETFs, some use a cash-based redemption mechanism, which generates more internal turnover and can lead the funds to generate capital gains.
According to some experts, the bigger factor this year was market conditions.
"You had a huge rally in fixed income this year, especially intermediate and longer-term Treasurys," Joel Dickson, a principal at Vanguard's investor strategy group, said in a telephone interview. "So for bond funds that maintain consistent average maturity versus the index they're tracking, they have to sell bonds that appreciated in value."
He noted that the fact the 10 Vanguard ETFs with capital gains distributions all have long-term gains is a clear indication that the challenge of managing a bond portfolio when fixed-income markets are rallying is not just confined to 2011.
Another aspect of IndexUniverse's data mining that bears mentioning is the divergent story lines from the two major U.S. purveyors of inverse and leveraged funds, ProShares and Direxion.
On the one hand, ProShares didn't report any capital gains distributions in 2011. That in itself is noteworthy, as any fund prospectus from either ProShares or Direxion clearly warns that the turnover required by daily-rebalanced portfolios should create a greater likelihood of capital gains distributions.
Direxion, however, had payouts in 25 of its 50 leveraged and inverse funds. Some of its funds had payouts on more than one date last year.
One important variable may be that Direxion specializes in triple-exposure funds, while ProShares focuses on double-exposure funds. The triple-exposure component may make Direxion's challenge a bit more significant.
The Direxion distributions do include a number of bullish Treasury funds, which dovetails with what Dickson of Vanguard spoke about.
But the capital distributions at Direxion also extend to a host of equity investments, including a bull and bear pair of ETFs focused on gold mining companies, which is more of a mystery.
In any case, a Direxion official who spoke to IndexUniverse on condition of anonymity stressed that it's always the company's aim to minimize such distributions.
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