WEEKEND INVESTOR
The Myth of Cheaper ETFs
Open-end index funds often charge lower fees—and are at least as tax-efficient.
By MARK HULBERT
Updated March 28, 2014 5:47 p.m. ET
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Tax efficiency.
Capital-gains distributions aren't a factor for investors in 401(k)s or other tax-deferred accounts, of course. But in taxable accounts, capital-gains distributions make a big difference.
As their champions will tell you, ETFs have an advantage in this regard, since their structure allows them to be managed in ways that reduce capital-gains distributions relative to a comparable open-end fund.
But that advantage shouldn't be exaggerated, according to David Blanchett, head of retirement research at Morningstar Investment Management, the advisory arm of Morningstar. "In most cases, the difference in after-tax returns between an open-end index fund and a comparable ETF is not going to be that material," he says.
One reason: Open-end funds also have ways of reducing capital-gains distributions, according to Lawrence G. Tint, chairman of Quantal International, a risk-management firm for institutional investors. Until 2000, Mr. Tint also was U.S. CEO of BGI, the organization that created iShares, which is now owned by BlackRock.
He points out that open-end index funds often have a large pool of "tax-loss carry-forwards"—capital losses realized in previous years that they can use to shelter capital gains they would otherwise have to distribute to shareholders.
The open-end funds with the greatest ability to shelter capital gains are those that have existed for a number of years and are benchmarked to a broad market index, Mr. Tint says.
A rule of thumb for investors worried about tax efficiency would be to choose ETFs when the comparable open-end fund is young or benchmarked to a single sector.
Otherwise, he says, when taking all costs of ownership into account, an investor most likely will be slightly better off in an open-end index fund.
Mr. Nadig adds, however, that because the costs of ownership vary from fund to fund and will change over time, "it's hard to paint broad brush strokes" in declaring that either ETFs or open-end index funds are the lower-cost alternative.
That means investors need to pay close attention to these various factors and be prepared to switch if and when circumstances change. (Two websites that provide relevant data are ETF.com and Morningstar.com.)
The table above, based on Morningstar data, lists no-load open-end funds and ETFs in various asset classes with low costs of ownership.
—Mark Hulbert is editor of the Hulbert Financial Digest, which is owned by MarketWatch/Dow Jones. Email: mark.hulbert@dowjones.com |
