ETF Capital Gains???!!!

[joelle]

This question is giving me a heck of a time. Any explanations would be appreciated.
Which of the following financial products is least likely to have a capital gain distribution?
A. Exchange Traded Funds
B. Open-end mutual funds
C. Closed-end mutual funds

 

[cfa_candidate_2011]

I think its A) exhcange traded funds. its because exchange traded funds always trade at NAV, as authorized participants will always make the shares to trade at NAV.
( I haven’t gone through portfolio managment so far, just making a guess based on what i learned on equity section).

 

[joelle]

The correct answer is A) Exchange Traded Funds, but the reason is not that of trading at NAV (see question 12 in 1st reading of PM: open-end funds trade closest to NAV). The textbook states the explanation as:
“ETF’s do not have capital gain distributions. If an investor sells shares of an ETF (or open-end mutual fund or closed-end mutual fund), the investor may have a capital gain or loss on the shares sold; however, the gain (or loss) from the sale is not a distribution.”
So does this mean that if the stocks’ values appreciate in the ETF, from say $100 to $150, the NAV of the ETF is still $100??? While for open-end and closed-end funds the NAV climbs to $150???

 

[cpk123]

In ETFs they have the in-kind redemption process. So the ETF can “automagically” create shares / destroy shares at no cost to the investor. So if there are profits - those are distributed as new shares to the investors. If there are losses - shares are reduced. This process reduces the impact of taxes to the investor.

 

[joelle]

Thanks a ton, that clarifies things a lot. So if I understood correctly, for funds (whether open-end or closed-end) the gains are appreciation in the value of the existing shares. Is there a place in the textbook where they mention that? I wonder why they haven’t, that would facilitate things!

 

[discovering]

Is the tax benefit in ETF’s is because of the reason that underlying asset of the ETF remains the same in the event redemption of units of that ETF? that means when someone sells their share in ETF they are selling only their share and not the underlying asset itself so they are not brought under the capital gain tax which would arise in the event of sale of that underlying asset but are there any tax laws that taxes the sale of units of ETF’s?