ETFs from largest US issuers will largely escape capital gains

Just six ETFs from the five largest ETF issuers will have any capital gains distributions in 2023, according to data from Morningstar Direct.

Schwab Asset Management has announced there will be no capital gains distributions for the 2023 tax year across its $302.6bn suite of 30 ETFs.

The announcement follows similar ones made recently by its largest competitors in the ETF space.

Last month, State Street and Vanguard estimated that none of their ETFs would pass along capital gains, the companies’ respective websites show.

This article was previously published by Ignites, a title owned by the FT Group.

Also last month, BlackRock said that just five of its 427 ETFs would pass along capital gains.

iShares’ $3.6bn MSCI Taiwan, $716mn India 50, $504mn MSCI India Small-Cap, $6mn MSCI Water Management Multisector and $5mn Breakthrough Environmental Solutions ETFs are the funds that BlackRock expects to have capital gains this year.

Those five ETFs accounted for just 0.2 per cent of BlackRock’s US ETF assets as of November 30, according to data from Morningstar Direct.

Invesco last month said that just one of its ETFs, the $182mn India ETF, would share a tax burden.

That ETF accounts for 0.04 per cent of Invesco’s US ETF assets, Morningstar data shows.

Overall, the five ETF shops manage a combined $6.56tn in assets across hundreds of ETFs, accounting for slightly more than 85 per cent of the $7.7tn US ETF market, according to Morningstar.

The five affected ETFs account for just 0.08 per cent of those five firms’ ETF assets and 0.07 per cent of the ETF industry’s assets under management, according to the Chicago researcher.

In some cases, that figure is in stark contrast to ETFs’ mutual fund counterparts.

Some 81 per cent of active equity mutual funds paid capital gains over the five years ended March 31, Morningstar data shows.

Despite a market rally this year, ETFs are largely shielded from capital gains, because of their “legal structure” and strong inflows this year, Lan Anh Tran, manager research analyst for Morningstar, wrote in a report this month.

ETFs’ legal structure allows for “in-kind” transactions, where ETF shares are swapped for individual securities and vice versa, which can avoid triggering taxable gains driven by investor redemptions and trades made by portfolio managers.

ETFs’ tax benefits aren’t “airtight”, Tran said.

Taxable investors can still be billed for regular distributions of income, she said.

One reason an ETF might distribute capital gains is if the ETF invests in foreign markets, Tran said.

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Some markets, including India and Taiwan, don’t allow those “in-kind” transactions, she said.

Sector equity ETFs were also among this year’s “heavy distributors”, because of a $22.6bn exodus from the sector year to date through October 31, Morningstar data shows.

“ETFs continue to gain market share from mutual funds,” Todd Rosenbluth, head of research at VettaFi, wrote in a report last month.

“Advisors and end clients are increasingly seeing many benefits, including a more tax-efficient approach to investing,” he said. “We think the continued lack of capital gains being passed on will further drive demand.”

*Ignites is a news service published by FT Specialist for professionals working in the asset management industry. Trials and subscriptions are available at ignites.com.