Why the $ 5.4 trillion ETF market faces its biggest crisis since its inception


Happy Thursday! Exchange-traded funds have been regarded as one of the best and most successful financial innovations in the markets over the past decades. Individual investors and institutions benefit from many strong attributes, but an important advantage, tax efficiency, could be taken out of funds, which could be a blow to industry experts, ETF Wrap told ETF.

We’re going to talk about the implications of a proposal from Washington, DC that created havoc among ETFs large and small. We will also discuss a new ETF offered by Goldman Sachs on which our colleague Christine Idzelis is reporting.

As usual, send any advice or comment, and find me on Twitter at @mdecambre to tell us what we need to jump on. Sign up here for ETF wrap.

The good and the bad
Top 5 winners from last week

%To recover

ETF NorthShore Global Uranium Mining URNM,


Global X Uranium ETF URA,


VanEck Oil Services ETF OIH,


VanEck Rare Earth / Strategic Metals ETF REMX,


Invesco Dynamic Semiconductor PSI ETF,

Source: FactSet, until Wednesday September 15, excluding ETNs and leveraged products. Includes ETFs traded on NYSE, Nasdaq and Cboe of $ 500 million or more
Top 5 drops from last week

% To recover

AdvisorShares Pure US Cannabis ETF MSOS,


KraneShares CSI China Internet ETF KWEB,
+ 0.03%


ETFMG Alternative harvest ETF MJ,


ETF Emerging Markets Internet & Ecommerce EMQQ,


Invesco China Technology ETF CQQQ,

Source: FactSet
A death knell for the ETF?

The proposal by the chairman of the US Senate Finance Committee, Ron Wyden, seeks to tax the ETF industry. As our readers are well aware, ETFs are baskets of securities that are as easy to trade as a stock and appeal to average investors for their convenience, if not also for their tax efficiency.

ETFs avoid taxes with so-called in-kind transactions.

The inherent tax efficiency of an ETF, which is typically built to mimic the performance of the index and tends to be inexpensive for this reason, is a direct result of the in-kind redemption of shares and the 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 is not a taxable event.

The process by which this occurs is complex and involves Authorized Participants, or PAs, and Market Makers, but ETF Trends explains it better here:

ETFs minimize tax obligations by paying large redemptions with stocks. The shares with the lowest cost base in the trust are returned to the redeemer. The result is an increase in the cost base of overall ETF holdings, but a reduction in capital gains. The low turnover means that ETF capital gains are relatively rare due to the creation / redemption process.

Wyden’s current proposal. However, this would cause capital gains to pass through the funds to millions of investors in ETFs, a rapidly growing segment of the US market, with some $ 5.4 trillion in assets, by the end of 2020, according to CFRA data. Mutual fund. meanwhile, with $ 20 trillion in assets, often pass on the capital gains incurred throughout the year when they sell stocks or bonds to raise funds and deal with redemptions.

The industry lobby group, the Investment Company Institute, or ICI, explained in a letter Wednesday that “the tax code’s treatment of in-kind fund redemptions helps prevent investors from incurring investment bills. ‘unexpected tax triggered by the actions of other investors, “but adding that the current rule” always ensures that fund investors pay all the tax they owe when they ultimately sell or redeem their shares. “

Todd Rosenbluth, Head of ETF and Mutual Fund Research, said ETF wrap that the proposal, if it gains traction and becomes law, “would be detrimental to many Americans.”

“The ability to limit and often avoid passing on capital gains to existing shareholders is one of the important advantages that ETFs typically offer in addition to intraday liquidity, low expense ratios and day-to-day transparency,” did he declare.

“If ETFs can no longer use in-kind redemptions and loyal shareholders are taxed at the end of the year for fund activity, that would be a burden on many middle class investors,” Rosenbluth said. .

ETFs Behemoth rose up against the proposal, which began to gain attention last Friday, an insider said.

Invesco, one of the largest ETF providers in the United States, said via an email spokesperson that the company “strongly disagrees with the principle of the proposed legislation and believes that instead of causing additional taxation for “high net worth investors and mega-corporations”, it will actually hurt the “average” taxpayer that Congress is trying to protect.

WSJ wrote that the proposed in-kind transaction tax is expected to generate $ 200 billion over a decade, based on estimates from the Joint Committee on Taxation.

A call to Wyden’s office on Thursday was not immediately returned.

The battle is on

Supporters of ETFs argue that these funds have democratized market access, giving investors of all stripes the ability to access areas and strategies they wouldn’t have easy access to without paying high fees.

Invesco argues that over 50% of people born between 1981 and 1996 view ETFs as the primary type of investment in their portfolios.

Industry participants also argue that ETFs are touted as an investment tool that only benefits the wealthy. Advocates of ETFs also note that longer-term holders would likely suffer the most damage under the Wyden proposal.

“ETF shareholders primarily realize capital gains taxes when they choose to sell their shares, so without protecting in-kind transactions from taxation, long-term investors would be harmed when others sell.” , Invesco wrote in a statement.

BlackRock, a giant of the fund, said the proposed “in-kind” taxation raises concerns for them.

“We would be concerned about policies that would increase costs and reduce returns for long-term investors and retirement savers, and are carefully reviewing Senator Wyden’s proposal to better understand its impact on millions of long-term investors. “the company said.

The ICI explained that Wyden’s tax proposal is more damaging to ETFs than mutual funds, which also use in-kind redemptions and creations, as they do much more in-kind redemptions.

“ETF shares are created and redeemed in large blocks in transactions between funds and large financial institutions known as authorized participants,” the ICI statement noted.

ETFs are dead?

Dave Nadig, Director of Research and CIO at ETF Trends, ETF Database, said ETF wrap that while the proposal, if carried out, would represent “a blow to the advantage that ETFs have traditionally enjoyed over mutual funds”, he considers that ETFs still retain a number of advantages.

These advantages include “generally cost, flexibility and negotiability, transparency,” Nadig wrote.

“So it’s not an ‘ETFs are dead’ situation. It just removes one particular advantage, ”Nadig said.

That said, while high net worth investors might be able to cope with the proposed tax changes, the average Joes and Janes would be grappling with the burden of paying the additional costs.

“I understand it’s an attractive argument that we are ‘taxing the rich’ here, but honestly the ETF has provided a clear and well understood tax-beneficial structure for any investor with $ 100 and a Schwab account,” did he declare.

“Wealthy investors have always had access to structured products, LLCs, entities and countless other structures to avoid short-term gains as part of a defined trading strategy,” he said. he declares.

Who owns ETFs

According to the ICI, nearly 12 million American households have ETFs. The median income of these households is $ 125,000 and 92% of all households investing in ETFs earn less than $ 400,000.

Goldman’s killer Cathie Wood?

Goldman Sachs has just launched an ETF targeting the next generation of technology companies, outside of the most popular companies already mentioned. The fund looks like some of those offered by Cathie Wood’s ARK Invest fund list and may be destined to take market share from ARK with a target on smaller companies.

MarketWatch colleague Christine Idzelis reports that the actively managed ETF GTEK Goldman Sachs Future Tech Leaders Equity,
+ 0.17%
will invest in listed companies with a market value of less than $ 100 billion and the fund will trade under the ticker symbol “GTEK”.

“We are now at a key inflection point where this innovation extends beyond the United States and down the market cap spectrum,” said Sung Cho, a GTEK portfolio manager at MarketWatch.

A number of fund providers have tried to ride the wave of revolutionary new technologies. Less than a month ago, The Future Fund LLC launched the actively managed Future Fund Active ETF FFND,

“We are looking for transformation opportunities that could develop over the next few years. Wrote David Kalis, CFA, partner at The Future Fund.

The race to the lowest

Rosenbluth notes that there are around 80 ETFs listed in the United States that charge a tiny fee of 0.05% or less. However, CFRA argues that fees should not be the only criteria on which investors base their fund selections. The composition of the fund and the file must also be taken into account.

“The CFRA believes that all things being equal, investors should consider cheap ETFs in a broad investing style. But with ETF investing, things are generally not level, ”writes the analyst.

Good ETF reads

-It’s a Wrap


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