• Follow us

Bermuda News

Vanguard fund investors get control of paying taxes | The Royal Gazette:Bermuda Personal Finance

Barry Ritholtz, Bloomberg

Published May 11, 2019 at 8:00 am (Updated May 11, 2019 at 12:05 am)

Barry Ritholtz

Barry Ritholtz

Related Stories

Last week’s big story about Vanguard Group’s patented tax dodge raised some interesting legal and tax issues. Our charge today is to try and take a slightly deeper look at what Vanguard has been doing and why.

Let’s start with some basics about the differences between mutual funds and exchange-traded funds, or ETFs. The obvious feature is that open-end mutual funds are priced once a day based on prices at the market close, while ETFs (and closed-end mutual funds) trade all day. This is a remnant of the pre-computer era, when it would have been impossible to get a quote on all of the underlying holdings in any given fund during market hours. If you have to execute buys or sells by hand, then end-of-day pricing data was what you used.

Investors in mutual funds buy or sell them directly from the mutual-fund companies themselves; ETF purchasers simply go to the market and buy ETFs at the quoted prices. This simple but important structural legal difference has significant tax ramifications for fund investors.

Mutual funds (and most ETFs) are governed by the Investment Company Act of 1940. This legislation treats them like a pass-though company. When a mutual-fund investor wants to sell, the fund sells shares of appreciated stock to generate cash, but also creating a taxable capital gain. Since most funds operate as simple pass-through vehicles, those tax liabilities from the gains accrue to investors in the fund — even to holders of the fund that were not sellers.

It feels inherently unfair that sellers of a fund are the ones who generate capital gains for nonsellers. Thus, the nonselling holders owe capital-gains taxes based not on when they decide to sell, but upon the vagaries of random fate.

Enter the ETF

ETFs avoid the tax issue because, unlike traditional mutual funds, they are not direct buyers or sellers of shares on behalf of a pool of investors. Instead, when a buyer of an ETF comes to market, a so-called authorised participant — a market maker with a special contract with the ETF provider — will create a block of shares of the ETF by buying all of the holdings in the underlying ETF. They then hand this off to the ETF issuer, and receive newly created ETF shares, which they can then sell to the market. When a seller comes along, it’s the same process in reverse.

Here is the sexy tax part of this: during creation or redemption, the fund issuers themselves aren’t buyers or sellers. Instead, they exchange shares of the ETF for shares of underlying stocks (creation) or they exchange shares of stocks for shares of the ETF (redemption). These are in-kind transactions, swapping one tradable security for another. It is not considered a cash transaction, so the great beauty of this to the ETF investor is there’s no pass-through capital-gains tax bill.

For this reason, ETFs have a huge structural advantage over traditional mutual funds. Not being hit with capital-gains taxes on funds you didn’t sell is part of the reason ETFs have seen such enormous growth. According to BlackRock, the world’s biggest asset manager, at the start of the century ETF assets amounted to less than $100 billion. Today that figure stands at $4.7 trillion. The company estimates that ETF holdings will increase fivefold during the next decade.

Given all of this, what did Vanguard Group do that was so innovative?

Instead of just creating a new family of ETFs, it decided to create them as a new share class within its existing mutual funds. It was such an inventive solution to the capital-gains tax problem that Vanguard and former chief investment officer Gus Sauter were awarded a patent.

ETF buyers would get access to Vanguard’s legendary cost-consciousness. The new products didn’t have the usual start-up struggles of high overhead costs spread out among few owners. Instead, they were instantly part of an enormous pool of existing assets. Thus, they received the full benefits of Vanguard’s economies of scale, including operating and trading costs. Not only that, but Vanguard got to tout the longstanding track records of the new ETFs. They were, after all, identical to the rest of the asset pool — just a new class of the same investments.

The biggest advantage, obviously, was the deferral of capital gains taxes for mutual-fund holders. As the company itself noted, “To meet cash redemption requests from non-ETF shareholders, Vanguard can sell high-cost-basis securities to generate a capital loss. These losses offset any current taxable gains and, if not exhausted, can be carried forward to offset future capital gains — a recycling that is not likely within stand-alone ETFs”. The ETF share class with a corresponding mutual-fund class effectively swaps shares to “wash out” or offset capital gains in the mutual fund.

Note that this is not tax avoidance, but rather tax deferral — investors must pay taxes on any gains made from selling the ETF shares for more than they paid. But fund investors get to make this decision themselves, based on when they choose to sell — not when someone else does.

Vanguard’s corporate structure as a mutual owned by its shareholders is unique in the asset-management business. So too is this ETF as a share class. It’s no wonder it won a patent.

•Barry Ritholtz is a Bloomberg Opinion columnist. He founded Ritholtz Wealth Management and was chief executive and director of equity research at FusionIQ, a quantitative research firm. He is the author of Bailout Nation

Read More



Leave A Comment

More News

All Stories

Thompson excited by return to Village 2019-05-21 10:48:00Kenny Thompson is hoping to pick up where he left off when he returns to Bernard Park as football director of North Village next season. Thompson h

Diabetes expert appointed at hospital 2019-05-21 10:47:00An expert on diabetes has been appointed as a consultant endocrinologist by Bermuda Hospitals Board.Andrew Jamieson, from Scotland, previously worked

Devonshire Parish Council scholarship 2019-05-21 09:45:00The Devonshire Parish Council is pleased to offer their Fall 2019 scholarship, with a maximum value of up to $5,000.00 per awardee for undergraduate a

Parish constable meeting in Devonshire 2019-05-21 09:14:00The parish constable for Devonshire will hold a meet and greet with residents this week.Kyle Outerbridge will host the session at J&J Produce, nex

Attempted armed robbery in Flatts 2019-05-21 08:53:00A man wielding a bladed article demanded cash from a store in Flatts today.Police were this afternoon hunting the suspect, who left empty-handed after

Coalition earns certification 2019-05-21 07:52:00An island charity charged with the protection of youngsters has earned certification. The Coalition for the Protection of Children earned the first of

Something for everyone at Guitar Festival 2019-05-21 07:41:00Bach, Bob Marley and Bon Jovi are all on the bill for music fans and the Bermuda Guitar Festival's line-up means there is something for everyone.The

Young people to star in cabaret 2019-05-21 07:17:00Loud Souls 2: A Cabaret featuring youth authors/performing artists in the Noire Youth Theatre CompanyOn Friday May 31st and Saturday June 1st at 6 an

Trash message from City of Hamilton 2019-05-21 07:08:00The Bermuda Day Weekend is upon us and the City of Hamilton reminds parade spectators to ensure that after the event on Friday, they take all of their

Dellwood to reopen after water issue 2019-05-21 04:00:00Children at a middle school were sent home early yesterday after a broken pipe stopped its water supply.The youngsters at Dellwood Middle School finis

Larry Woolgar (1952-2019) 2019-05-21 04:00:00The survivor of a brutal machete attack six years ago after a prowler broke into his home has died.Larry Woolgar, a former manager at the English Spor

Weather service watching Andrea 2019-05-21 04:00:00Subtropical depression Andrea will bring the chance of thunder and strong winds as it passes Bermuda.At noon today, the closest point of approach to B

Bernews.com

Bermuda Stock Exchange Report: May 21 2019 2019-05-22 05:15:40May 21 saw 7,015 shares trade on the Bermuda Stock Exchange, valued at $88,525.00 BD. 5,500 shares were traded by BF&M Ltd, closing even at...

Bermuda’s National Select Team Announced 2019-05-21 20:26:54The road to the Gold Cup continues when the Bermuda Men’s National Select team will play a match against Sao Miguel Azorean Select on Saturday,.

Terceira & Lopes Competing In The Netherlands 2019-05-21 19:00:56Jillian Terceira continued and Tyler Lopes began competing in the final Valkenswaard International Horse Jumping event in The Netherlands of the...

Minister Confirms ‘Buju Banton’ Can Perform 2019-05-21 18:50:52Minister of National Security Wayne Michael Caines has confirmed that permission has been granted for Mark ‘Buju Banton’ Myrie to visit an

BFRS Respond To Vehicle Incident In Smiths 2019-05-21 18:07:36Bermuda Fire and Rescue Service responded to a report of a vehicle fire in Smiths this morning [May 21] and arrived to find smoke coming from a...

30 Minute Video: May 21 ZBM Evening News 2019-05-21 17:40:10With an aim to expand the way they deliver their news to the community, the Bermuda Broadcasting Company is continuing to live stream their evening...

Weather Forecast For Wednesday May 22 2019-05-21 17:25:28Wednesday, May 22 is expected to be becoming partly cloudy after some morning rain, windy at times, with the high to be near 26°C/78°F and the

EMS: Emergency Medical Services Week 2019-05-21 16:31:33Bermuda’s Emergency Medical Services [EMS] are highlighting the work they do in the community this week, and you can join them outside City Hall

Police Cadet Wins Relay For Life Song Contest 2019-05-21 16:29:30Alnique Young-Looby, who entered and won the 2019 Relay for Life of Bermuda song competition. A police spokesperson said, “The Bermuda Police Se

Simons Re-Appointed To Olympic Commission 2019-05-21 16:23:00The Bermuda Olympic Association [BOA] today [May 21] announced that BOA President, Mrs. Judy Simons, has been re-appointed a member of the Olympic...

Video: Carnival Costume Design Challenge 2019-05-21 16:21:48Minister of Labour, Community Affairs and Sports Lovitta Foggo congratulated this year’s winners of the Cultural Apprenticeship Showcase. A...

Golf Director: Roy Joins Fairmont Southampton 2019-05-21 15:34:40Fairmont Southampton have welcomed Scott Roy as the new Director of Golf for Turtle Hill Golf Club at Fairmont Southampton. “Scott started

CaribDirect.com

Saint Lucia Shares Sports Illustrated Cover 2019-05-10 23:00:16CASTRIES, SAINT LUCIA (May 8, 2019) — The Caribbean island of Saint Lucia — the only country in the world named after a woman — is p

CARICOM divide must be bridged 2019-05-05 06:53:49It’s no secret that the countries of the Caribbean Community and Common Market (CARICOM) are divided over the response to the situation in Venez

Early grumblings in a government’s first term 2019-05-05 06:34:43Smart politicians pay heed to early disenchantment from voters. Why: because to be forewarned is to be forearmed Voter grumbling and voter discontentm

Name That Voice 85 2019-05-04 23:00:45Delia invites you to guess the name of the voice you hear in Name That Voice! It could be someone recently in the news, a celebrity, even a cartoon ch

Royal Caribbean’s New Liner 2019-05-03 23:00:58Writer Gene Sloan released information on Royal Caribbean’s new, as yet unnamed, liner this week. He confirmed that construction has begun on a

The Caribbean ideals of Alister McIntyre 2019-04-30 08:37:14Sir Meredith Alister McIntyre was born in Grenada but for much of his life, dedicated to promoting the interests of the Caribbean, few knew his birth

Name That Voice 84 2019-04-27 23:00:48Delia invites you to guess the name of the voice you hear in Name That Voice! It could be someone recently in the news, a celebrity, even a cartoon ch

Statement on the Terrorists Attacks in Sri Lanka 2019-04-27 01:00:53Chairman of the OECS Authority Dr. The Hon Ralph Gonsalves Monday, April 22, 2019 — Chairman of the Organisation of Eastern Caribbean States (OE

Name That Voice 83 2019-04-22 08:11:34Delia invites you to guess the name of the voice you hear in Name That Voice! It could be someone recently in the news, a celebrity, even a cartoon ch


Disclaimer and Notice:WorldProNews.com is not responsible of these news or any information published on this website.