By Mark DeCambre
Happy Thursday! Exchange-traded funds have been referred to as one of the best financial innovations and the greatest success story in markets over the past few decades. There are many solid attributes to ETFs that are enjoyed by individual investors and institutions alike but one important benefit, the tax efficiency, could be stripped away from the funds, delivering a potentially damaging blow to the industry, experts told ETF Wrap .
We’re going to talk about the implications of a proposal coming out of Washington, D.C. that has raised the hackles among large and small ETF providers alike. We’ll also touch on a new ETF on offer by Goldman Sachs that our colleague Christine Idzelis is reporting on.
As per usual, send tips, or feedback, and find me on Twitter at @mdecambre to tell us what we need to be jumping on. Sign up here for ETF Wrap .
The good and the bad
|Top 5 gainers of the past week||%Return|
|NorthShore Global Uranium Mining ETF /zigman2/quotes/215396693/composite URNM||15.1|
|Global X Uranium ETF /zigman2/quotes/201570425/composite URA||9.2|
|VanEck Oil Services ETF /zigman2/quotes/207596637/composite OIH||3.9|
|VanEck Rare Earth/Strategic Metals ETF /zigman2/quotes/205602686/composite REMX||3.4|
|Invesco Dynamic Semiconductors ETF /zigman2/quotes/209181828/composite PSI|
|Source: FactSet, through Wednesday, Sept. 15, excluding ETNs and leveraged products . Includes NYSE, Nasdaq and Cboe traded ETFs of $500 million or greater|
|Top 5 decliners of the past week||% Return|
|AdvisorShares Pure US Cannabis ETF /zigman2/quotes/220307682/composite MSOS||-7.1|
|KraneShares CSI China Internet ETF /zigman2/quotes/205873167/composite KWEB||-6.8|
|ETFMG Alternative Harvest ETF /zigman2/quotes/204332491/composite MJ||-6.3|
|Emerging Markets Internet & Ecommerce ETF /zigman2/quotes/205406984/composite EMQQ||-5.1|
|Invesco China Technology ETF /zigman2/quotes/203596391/composite CQQQ|
An ETF death knell?
U.S. Senate Finance Committee Chairman Ron Wyden’s proposal aims to tax the ETF industry. As our readers well know, ETFs are baskets of securities that are as easy to trade as a stock and appeal to average investors for its convenience if not also for its tax efficiency.
ETFs defer taxes with so-called in-kind transactions.
The inherent tax efficiency of an ETF, which usually is constructed to mimic the performance of index and tends to be low-cost for that reason, is the direct result of the in-kind redemption of shares and creation of new ones. Currently, in-kind tax treatment is governed by section 852(b) (6) of the Internal Revenue Code, and provides that the creation of new ETF shares and the redemption of old ones isn’t a taxable event.
The process by which this occurs is complex and involves Authorized Participants, or APs, and market makers, but ETF Trends explains it best here:
Wyden’s current proposal. however, would result in funds passing on capital gains to millions of investors in ETFs, a rapidly growing segment of the U.S. market, boasting some $5.4 trillion in assets, as of the end of 2020, according to CFRA data. Mutual funds. meanwhile, with $20 trillion in assets, often pass along capital gains incurred throughout the year as they sell stocks or bonds to raise cash and meet redemptions.
Industry lobbying group the Investment Company Institute, or ICI, in a Wednesday letter explained that “the tax code’s treatment of funds’ in-kind redemptions helps prevent investors from incurring unexpected tax bills triggered by other investors’ actions,” but adding that the current rule “still ensures that fund investors pay all the tax that they owe when they ultimately sell or redeem their shares.”
Todd Rosenbluth, head of ETF & Mutual Fund Research, told ETF Wrap that the proposal if it gains further traction and becomes a law would “be harmful to many Americans.”
“The ability to limit and often avoid passing along capital gains to existing shareholders is one of the important benefits ETFs typically provide in addition to intraday liquidity, low expense ratios and daily transparency,” he said.
“If ETFs no longer can utilize in-kind redemptions and loyal shareholders are taxed at year end for fund activity it would be a burden to many middle class investors,” Rosenbluth said.
Behemoth ETFs were up in arms over the proposal, which started to gain attention last Friday, one insider said.
Invesco, one of the U.S.’s biggest ETF providers, said through a spokeswoman via email that the company “strongly disagrees with the premise of the proposed legislation and believes that instead of resulting in additional taxation for the ‘wealthy investors and mega-corporations,’ it will actually hurt ‘average’ taxpayer that Congress is trying to protect.
WSJ wrote that the proposed in-kind transaction tax are expected to generate $200 billion over a decade, based on estimates by the Joint Committee on Taxation.
A call to Wyden’s office on Thursday wasn’t immediately returned.
The battle is on
Proponents of ETFs make the case that those funds have democratized access to the market, giving investors of all stripes the ability to gain access to areas and strategies that they would not easily get access to without paying hefty fees.
Invesco makes the case that more than 50% of those born between 1981 and 1996 consider ETFs the primary investment type in their portfolios.
Industry participants also argue that ETFs are being billed as an investment tool that solely benefit the wealthy. Advocates of ETFs also note that longer-term holders would likely see the greatest harm under the Wyden proposal.