Tax liability calculation

The procedure starts with gathering information on each of the aforementioned components of taxable income. Hence, the historical per share data shown in Table 5.3, were obtained for each taxable component from State Street Global Advisors, the SPY's trustee and from Vanguard for VFINX. Because ordinary income and short-term capital gains are taxed at the investor's marginal tax rate, they were grouped together in Table 5.3 without fear of consequential loss of information. Next, because a...

IShares offer tax benefits in relation to mutual funds

IVV's per share distribution and net asset values at time of distribution were obtained from Barclays Global Investors. They were used to calculate per dollar distributions as shown in Table 5.6. Using the tax brackets shown in Table 5.6 iShares 500 index fund (IVV) historical distributions Distributions per share* Distributions per dollar invested Table 5.6 iShares 500 index fund (IVV) historical distributions Distributions per share* Distributions per dollar invested Note * Distributions per...

Calculation of stock performance

Now that we have a basic understanding of the principles that underline their calculations, we review in this section how these indexes are calculated. Obviously, constructing an aggregate measure of stock market performance is not as easy as it may initially appear. It is clear by now that coverage is not the only feature setting these indexes apart from each other their construction must address several other concerns, including the weight given to each security included in the index. For...

ETFs mass appeal in Europe is still doubted

In spite of the many common features of European offered ETFs and US ETFs, doubts remain as to the ability of the former to mirror the latter's 1 Morgan Stanley, Exchange-Traded Funds Strategies, August 19, 2004. Table 9.1 Europe's iShares MSCI ETFs change in TER (bps) Table 9.1 Europe's iShares MSCI ETFs change in TER (bps) Source Morgan Stanley, February 1, 2005. success. Critics believe that it is one thing to rival the United States in terms of the number of traded ETFs, but quite another...

The Rebalancing Process

Both ETFs and index-based mutual funds share inherent tax efficiencies. As index funds, they have a relatively low turnover since they only buy and sell stocks to adjust for changes to their underlying benchmark. As such, both investment vehicles experience lower capital gains distributions and tax liability than their actively-managed funds counterparts. Actively managed This chapter draws from the author's previous work on the subject. See, A. Seddik Meziani, Along Came a SPDR How...

Main Differentiating Characteristics Of Market Indexes

Once an asset manager has decided to pursue an index strategy, the next step is to select an appropriate benchmark. Although market indexes tend to move in unison, there are important differences in the magnitude of these moves. Whether passive investors prefer indexed mutual funds, favor ETFs, or an asset allocation strategy that uses both, they need to understand how these indexes are compiled as the differences in construction can lead to significant differences in returns. Indeed, we cannot...

Strategy 4 Many ETFs are considered similar yet are certainly not identical

To illustrate, assume that the hypothetical investor sells 200 shares of the iShares Dow Jones Technology-Index (IYW) at a loss. Repurchasing within the disallowed period the same number of shares of the IYW for tax purposes will be disallowed by the IRS. Realized losses cannot be applied against the capital gains distributions our investor could receive, without triggering the wash-sale rule. However, the loss on the sale of the IYW could be claimed without violating the wash-sale rule if...

Actual Tax Savings Methodology

In order to assess the potential tax savings of ETFs over competing indexed mutual funds, we will compare the SPDR 500 (SPY) and the Vanguard 500 (VFINX). The former accounts for over 26 of the ETF market 1 This chapter draws from the author's previous work on the subject. See, A. Seddik Meziani, Along Came a SPDR How Tax-Efficient are S& P Depositary Receipts in A Guide to Exchange-Traded Funds, Institutional Investor, Fall 2001, pp. 144-154. Source American Stock Exchange (October 1,...

Taxfree inkind redemption

When a unit holder of the ETF Trust requests redemption, the Trust may distribute securities and or cash. In the case of cash, no capital gain is involved on the part of the Trust. However, in the case of securities, the current market value of the securities may have gone up should the Trust recognize the capital gain or loss Internal Revenue Code Section 311(b) provides that if a corporation distributes property to a shareholder and the fair market value of such property exceeds its adjusted...

The 12b1 fee

The cost differential shown in Table 3.2 is also due to a charge called the 12(b)-1 fee.9 This charge is levied to cover the cost of marketing and distributing the fund. Assessed annually for as long as the fund is owned, it can amount to as much as 1 . Box 3.2 describes how mutual funds use 12(b)-1 fees. Unlike mutual funds, ETFs can only be purchased through brokers rather than directly from the fund sponsors. Sponsors do not sell shares directly to the public. Therefore, they save the cost...

Tax Efficiency Of Redemption

As noted, the distribution of stock by the trust to ETF shareholders for redemption does not realize any capital gains. Moreover, ETF managers can also chose to distribute low-cost stocks to the redeeming shareholders, leaving high-cost stocks in the portfolio's holdings. Later, when these high-cost stocks are sold, lower capital gains will be realized. Hence, ETF redemptions provide an opportunity for their managers to avoid capital gains. If these acts are well - coordinated, the ETF Trust...

The premium and discount issue of international ETFs

Due to their hybrid nature, ETFs present portfolio managers with additional risks. Generally speaking, as discussed in chapter 3, the market price is determined by supply and demand for these funds because they trade like securities. As such, a specialist can create or redeem ETFs through creation units new shares are created to meet demand or terminated to control supply. Yet, although it is true that the market price of any ETF is largely driven by the underlying value of the portfolio, they...

Market indexes as proxy for systematic risk

Last but not the least, the concept of systematic risk has also contributed to the use of market indicator series. Also known as market risk, it stems from factors that systematically affect most firms, such as high interest rates, inflation, recessions, and war. Since most stocks are negatively affected by these factors, market risk cannot be eliminated by diversification. Hence, it is also known as undiversifiable risk. Since this risk is inherent in the market, it can be measured by the...

Fair pricing and liquidity

ETF pricing and liquidity stem from three main sources the creation and redemption process the trading of shares on the secondary market and transparency. ETFs do not have a fixed number of shares.2 Authorized participants or market makers can issue and redeem shares of the ETF fund at any time, in large blocks of the fund's shares, called creation units or a standard basket, these replicate the underlying index. Authorized participants are those broker dealers, institutional investors, or...

Indexing and ETFs

ETFs are an outgrowth of index funds. Like with index funds, investors can take a position in the market without selecting individual securities. ETFs represent a basket of securities based on a particular index. Purchases or redemptions of an index fund, however, only occur at the end of the day when the fund's net asset value is calculated. ETFs overcome this limitation since they trade continuously on the major stock exchanges like ordinary stocks. Hence ETFs offer investors the benefits of...