Clients know they shouldn’t fixate on returns. It’s only the returns they get to keep that count, which is why you shoulder your way through the crowded field of investments to secure your clients the best after-tax returns possible. Exchange traded funds (ETFs) make it easy to be your clients’ star tax quarterback.

ETFs tend to be more tax efficient than conventional mutual funds while still providing the safety of broad diversification. Exchange traded funds generally track an index by holding the same stocks in the same proportion as the target index. This makes ETFs very well diversified and singularly tax efficient.

Every time a conventional mutual fund manager sells a position within the fund, capital gains (or losses) are likely to result. Funds with an aggressive management style can turn over their portfolio more than 100% in a year, racking up tax liabilities for unitholders. ETFs, on the other hand, have very low portfolio turnover because they sell investments only when the index changes. This means ETFs generally generate lower capital gains distributions than actively managed mutual funds.

ETFs have another tax advantage: sales of units that take place on the Exchange have no direct tax consequences on the fund. A conventional mutual fund can generate a capital gains tax liability when unitholders sell their units, because the fund may be forced to sell some of its holdings to pay the redeeming unitholders. ETFs, on the other hand, are typically bought and sold by investors through the facilities of the stock exchange, so the underlying fund is not directly impacted by selling. It is only when there is sustained net selling by individuals, or when an institution wishes to dispose of a very large position, that an ETF will be forced to sell its holdings.

When this happens in Canada, a deemed disposition occurs and can trigger a capital gain or loss. In the U.S., however, these in-kind redemptions are non-taxable at the (exchange traded) fund level. This difference in tax treatment makes U.S. based ETFs even more tax efficient than Canadian ETFs and less likely to distribute capital gains than Canadian ETFs.

Lower taxable distributions translate into better after-tax returns for your clients.

And if you can achieve that without sacrificing diversification, that’s a winning touchdown.

Sponsored by Barclays Global Investors Canada Limited
Contact Howard Atkinson at howard.atkinson@barclaysglobal.com

Commissions, management fees and expenses all may be associated with Exchange Traded Funds. Please read the relevant prospectus before investing. Mutual funds are not guaranteed, their values change frequently and past performance may not be repeated. BGI’s ETFs, other than iUnits, are not qualified for distribution to the public in Canada as no prospectus has been filed for such funds with Canadian securities regulators.