Home > ETF Provider: The Hunt For Tax Efficiency (SPY, DIA, IWM, QQQ, VTI)

ETF Provider: The Hunt For Tax Efficiency (SPY, DIA, IWM, QQQ, VTI)

November 15th, 2011

Jennifer Grancio: Last year, my colleague Kevin Feldman published a blog on Tax Day, reminding investors about the overlooked cost of capital gains. Well, iShares recently released its estimated 2011 capital gains distributions, so I thought it would be a good idea to revisit this topic and talk about the importance of considering capital gains when evaluating an ETF provider.

ETFs have a reputation for typically distributing fewer and lower capital gains than their active mutual fund counterparts. Capital gains can be generated when a fund needs to buy and sell securities due to events like shareholder activity, index rebalancing or diversification requirements.

But for the taxable investor, capital gains represent an additional cost – not in the form of fees paid to the fund company, but in tax payments made to the IRS. In this environment, where every dollar counts, tax efficiency has emerged as a valuable attribute of ETFs.

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But not all ETF providers are alike when it comes to their ability to manage for tax efficiency.

Take for example the 2010 capital gains distributions for the three largest ETF managers. Despite offering more than twice as many ETFs as the other two providers, less than 3% of the iShares funds paid cap gains in 2010. Of course, it is important to note that past distributions are not indicative of future distributions.

For 2011, 231 out of 233 iShares funds – or 99% — are not expected to pay a capital gains distribution. In the last 10 years, iShares ETFs have not paid capital gains 99% of the time.

Why this difference in capital gains distributions? Portfolio managers must balance a variety of factors when seeking to manage capital gains. For instance, sectors that experience significant appreciation may present limited opportunities for a fund manager to balance gains with losses, or index changes may create inopportune but necessary trades from a tax perspective.

Tax efficiency can be challenging, and there are no guarantees. The tax man may still have to be paid – but by evaluating your ETF choices closely, maybe not as much.

2011 estimated iShares ETF capital gains distributions do not take into account any possible tax reclassifications, nor does this estimate contemplate changes in income or shares outstanding that may occur prior to record date.

All regulated investment companies are obliged to distribute portfolio gains to shareholders at year’s end. Trading shares of the iShares Funds will also generate tax consequences and transaction expenses. This material is not intended to be tax advice. The tax consequences of dividend distributions may vary by individual taxpayer. Please consult your tax professional or financial advisor for more information with regard to your specific situation.

Past performance does not guarantee future results.

Investment comparisons are for illustrative purposes only and are not meant to be all-inclusive. To better understand the similarities and differences between investments, including investment objectives, risks, fees and expenses, it is important to read the products’ prospectuses.

Written By Jennifer Grancio From The iShares Blog

iShares believes in openness, transparency, and honesty. It’s how we fulfill our mission: empowering investors and investment professionals to achieve their goals. The iShares Blog furthers that commitment, by providing visitors to the Blog with market insights and analysis from some of the preeminent thought leaders at iShares.



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