Exchange traded funds

I read the stalla notes regarding the exchange-traded funds but can’t get " since no shreas are bought or sold for cash at the fund level, no capital gains are realized for the remaining ETF shareholders when ETF shares are redeemed." Can anyone help me? How does it works in the real world? Thanks

What I think they are trying to say is that an ETF is simply like a “Trust” similar to an ADR. This “Trust” holds the shares within the fund and since ETF’s are passively managed (according to the text) these shares in the “Trust” are not bought and sold, and the value of the ETF will represent the value of the shares. No capital gains will be realized for the remaining ETF sharesholders, but you would still need to realize any gains or losses. Main difference between ETF’s and mutual funds for tax purposes: You will pay capital gains taxes on mutual funds each year, but not on ETF’s if you buy and hold. For ETF’s, it is the same as holding actual stocks, you pay capital gains taxes after you realize them upon the sale. Hope this makes sense…

thanks. rlange. what is the difference between ETF and closed-end, open-end investment. do you mean that holding gain from ETF is not taxable. But there is holding gain, just like interest, dividend right? Thanks

rlang, take the QQQQ as an ETF, since it has 100 stocks representing the Nasdaq 100, how was it created? I assume it was created by the trustee, whoever that is, by buying x shares of each stock in the index. Is x proportionate to the weight of the stock in the index? So, if MSFT makes up 2% of the Nasdaq 100, then they put 2% of their money into MSFT. They then issue shares called QQQQ, and let the market price them. Of course due to arbitrage the price of the QQQQ cannot deviate much, if any, from the value of the actual shares in the trustee’s fund. So, when some people sell their QQQQ shares, they pay capital gains as normal. The trustee cannot sell the underlying shares, no matter what (right?), until termination of the trust fund, 50 years or some other long period. Not sure what happens to dividends that that trust fund receives? My guess is that, they get added to the fund without anyone paying taxes on them! An interesting aspect of this is that when stocks pay dividends their share prices drop by the amount of the dividend. Since the ETF is priced in relation to the market prices of the underlying stocks, the ETF should drop in price as well. But if dividends are added to the ETF, then the ETF price would be higher than should be (which can’t happen due to arbitrage). So where do the dividends go?

hi Guys ETF and closed ended funds are the same.But ETFs are more close than NAV.They avoid premium/discount on NAV. Close ended funds are always traded at premium and discount.u can think of this as u put the order in the morning and u have to wait till evennin means closin of market. Open ended funds are traded at NAV value.Most MF are alwys open ended. ny more sugession. cheers Abhi

I think ETF’s and closed end funds are pretty different. ETF’s trade at close to their NAV because of in-kind creation and redemption. If the ETF is trading too low, I buy it and then redeem my shares in the ETF for the underlying shares and vice versa (sorta). Dividends from underlying are just passed to investors as dividends from the ETF (there’s a lag there were they probably just put dividend proceeds in some account at a cash management place).

Good to know that dividends are paid to holders, and not plowed back in, because that would not make the ETF mirror its index. How does the ETF trustee make its money? If they deduct some small percentage (say 1%), what do they deduct it from? When I buy the ETF I am buying it in the secondary market, from a fellow trader like me. The commissions for trading go to our friends the brokers. So how does the trustee make its money, *other than* at the inception of the ETF? Any thoughts?

They get paid a management fee. For SPY, e.g., the trustee (State Street) gets 6 bp/year.

From where is that deducted? SPY’s price mirrors S&P 500. If SPY’s price closes the year Dec 31st at $100, the trustee holds S&P 500 shares, not my ETF’s. How can he charge the 6 bp/yr? Of course, the trustee can have a cut from dividends, but what if an ETF has no dividends? I’m just trying to clarify something I don’t really understand.

I don’t exactly know how they do it, but it’s probably laid out in the prospectus. The usual way these things are done is that it is accrued daily. I expect that for in-kind redemptions, your available shares drops by an annual rate of 6 bp (plus some other stuff so total expense ratio is like 15 or something). So if you own 100 shares of GE at the beginning of the year, you are entitled to 99.85 shares at the end of the year.