08. Lower Operational Costs & Taxes

Operational Costs and Taxes

ETF sponsors can charge more competitive (lower) fees in part because their transactions can be more tax efficient. If you think of how individual investors are taxed on their investments, selling a stock at a higher price than when they bought it will be considered a “realized” capital gain. Investors pay taxes on the cash they earn from capital gains. For an ETF Sponsor, recall that when it enters a create or redeem process, stocks and ETF shares are being exchanged, and not cash. Also, the dollar value of these assets being exchanged are more or less equal.

Let’s look at a pretend example. Let’s say an open-end mutual fund is handling investor redemptions, and so the fund sells $10,000 worth of stocks to improve liquidity and handle the redemptions. The fund originally bought those stocks at a value of $9,000, and so realizes a capital gain of $1,000, which is taxed.

Let’s also pretend that an ETF sponsor is entering a redeem process with an AP, and gives $10,000 worth of stocks to the AP, in exchange for $10,000 worth of ETF shares. There is no realized capital gain, so there is no tax.