The ETF industry could be a big winner if President Biden is successful in passing his capital gains tax hike proposal, according to new analysis from CFRA Research.
The advantage of ETF investing in an environment where capital gains taxes could go as high as 39.6%, as they would under Biden’s proposal, is multifold, according to Todd Rosenbluth, CFRA’s head of ETF and mutual fund research.
“Just three of the 585 equity ETFs offered by iShares, Invesco, Schwab State Street Global Advisors, and Vanguard, and star rated by CFRA, passed along any capital gains to shareholders in 2020 that maintained positions throughout the year,” Rosenbluth said.
That is very different than many mutual funds that did pass along capital gains burdens even to loyal shareholders who stayed invested in their funds all year, he said.
“ETF-focused advisors and investors in 2020 received fewer surprises at year end and we expect more people that mix ETFs and mutual funds together will be more inclined to shift toward strategies to avoid paying higher capital gains taxes in the future,” Rosenbluth said.
Tax efficiency will become even more coveted in an increasing tax rate environment, he said. ETFs are generally more tax efficient than mutual funds because, unlike mutual funds, ETFs generally do not sell securities when investors redeem their shares, Rosenbluth said. Instead, ETFs “do most of their trading in the secondary market where they are able to cross their sell orders with buy orders,” he said.
As a result, “ETF redemptions by other shareholders do not typically create a taxable event for long-term ETF holders as they would with mutual funds,” Rosenbluth said.
According to CFRA, “Market-cap weighted ETFs such as iShares Core S&P 500 ETF (IVV) and Technology Select Sector SPDR (XLK), smart-beta ETFs such as Invesco S&P 500 Equal Weight ETF (RSP) and Vanguard Dividend Appreciation ETF (VIG), as well as actively managed BlackRock U.S. Equity Factor Rotation ETF (DYNF) and Vanguard US Multifactor ETF (VFMF) all incurred zero capital gains in 2020."
Zero capital gains will become even more attractive to wealthy individuals, who could see their federal rates soar as high as 43.4% if Biden and Democrats are able to pass a 39.69% capital gains hike, the report said.
iShares Evolved U.S. Innovative Healthcare ETF (IEIH), with $37 million in assets, was responsible for the largest capital gain as a percentage of net asset value. “This actively managed sector fund paid out capital gain of $0.57 a share, equal to 1.7% its NAV,” Rosenbluth said.