Author Topic: Managed Funds v ETFs - Tax implications  (Read 546 times)

misterhorsey

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Managed Funds v ETFs - Tax implications
« on: June 03, 2019, 07:41:31 PM »
I currently own a Vanguard Fund (Wholesale High Growth) and Vanguard ETFs (VAS + VGS).

And I'm starting to think perhaps that ETFs are the way to go from now on, particularly since Vanguard have introduced new diversified ETFs: VDHG

But I would appreciate the thoughts of other MMMers on this.  It's a longish post so thanks in advance if you make it to the end.  Perhaps its good to outline these issues for others considering between the two investment vehicles.
 
Funds and Capital Gains

One thing I've noticed, to my dismay, is the incidental tax consequences of holding the Fund over the ETFs. Basically they have a tendency to give you a large amount of capital gains at the end of each year, generated from within the Fund.  These capital gains are independent of any buying and selling of any units you may hold.

My understanding is that the Fund needs to buy and sell shares as investors buy and sell units in the Fund, but also as certain companies may fall in or out of the index. So this creates capital gains which the Fund then has to distribute to it's unit holders.

In the 2018 Financial year I received an assesable capital gain just shy of $17k on a balance of $347k.  That's about 4.8% of the value of my investment in the fund returned to me as a assesable capital gain. Meanwhile the VAS and VGS ETFs showed negligible capital gains.

As it is taxed at my marginal rate, and that rate is relatively low, it's not the end of the world. But it does bump up the overall taxable income as well and so it's hard to plan for these events.

There are other factors to consider - franking credits distributed through the Fund, an adjustment to the cost base of the units - so it's not just the capital gains that are an issue. And there are many good reasons to invest in a fund over the ETFs: convenience, no brokerage, psychological (regular drip feed v timing the market), automatic re-balancing. But I'm slightly annoyed that this unique feature of the Funds wasn't made a little more clear to me in all the literature by Vanguard describing their products.  I appreciate that Vanguard don't really spruik or promote their products that heavily, and they frequently advise you need to seek independent financial advice, so perhaps an advisor would have brought this issues up at the beginning.

I also realise that these higher levels of capital gains may be a result of a sustained bull market and may not be such an issue in more bearish times, but the effect of these capital gains acts as a significant drag on the performance of the fund.  As well as being an administrative pain.  (If anyone can point me in the direction of how to deal with adjusting the cost base of units to account for the adjustment each year, when the units in a fund are bought over many many years - it would be appreciated!!).

Of course, is it possible that I'm misinterpreting this?  Is the relative performance of a Fund and ETF exactly the same, and the value is incorporated into the unit or ETF price?  It doesn't feel like it, particularly if the gains are crystalised and real money is becomes payable for a capital gains tax liability.

Or are ETFs truly more tax effective than a Fund?  And that this issue with Funds has been accepted because of the benefits of diversification and there was no other way to managed such large funds with so many investors until they developed more refined ETFs?  And perhaps also these wholesale funds were primarily held by high net worth individuals and insulated inside weird trust structures where income was more easily smoothed out and tax issues managed?

The introduction of diversified Vanguard ETFs would seem to address this issue. This article I found certainly thinks so:

https://www.bloomberg.com/opinion/articles/2019-05-06/vanguard-fund-investors-get-control-of-paying-taxes


What am I going to do?
It seems to me that the sensible thing to do would be to shift my investments in the High Growth Fund into the High Growth ETF.  This has the potential to trigger more capital gains, so I shouldn't do it if I'm going to end up with a huge tax bill. However, I should be able to get some of it over with no impact.  I'm also not working at the moment so the marginal tax rate i'm paying is pretty low.

The Diversified ETF seems to have the benefits of diversification, automatic rebalancing, but in a much more tax effective frame work.

I do like to pay my share of tax. But I didn't anticipate that the Fund would spring a tax liability surprise at the end of each financial year, which makes it hard to plan.  And I wanted to check with the MMM hivemind just in case I'm missing something and I make another mistake!

 
References:

VGS
https://www.vanguardinvestments.com.au/retail/ret/investments/product.html#/fundDetail/etf/portId=8212/assetCode=equity/?overview

VAS
https://www.vanguardinvestments.com.au/retail/ret/investments/product.html#/fundDetail/etf/portId=8205/assetCode=equity/?overview

Vanguard High Growth Fund
https://www.vanguardinvestments.com.au/retail/ret/investments/product.html#/fundDetail/wholesale/portId=8134/assetCode=balanced/?overview


VDHG
https://www.vanguardinvestments.com.au/retail/ret/investments/product.html#/fundDetail/etf/portId=8221/assetCode=balanced/?overview

mrmoonymartian

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Re: Managed Funds v ETFs - Tax implications
« Reply #1 on: June 05, 2019, 01:37:42 AM »
I guess the moral of the story is that one good churn deserves another... mutual fund sucker to pick up the capital gains tax bill.

Don't worry, I only realised recently that capital gains are called that because they mostly end up in Canberra.

marty998

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Re: Managed Funds v ETFs - Tax implications
« Reply #2 on: June 05, 2019, 02:07:29 AM »
No, you are not misinterpreting it, although capital gains are distributed to ETF holders as well each year. I don't recall it being that large however.

  (If anyone can point me in the direction of how to deal with adjusting the cost base of units to account for the adjustment each year, when the units in a fund are bought over many many years - it would be appreciated!!).


For the managed fund, Vanguard will keep track of your unit cost basis, and when you eventually redeem they'll provide you with an additional tax schedule for that.


misterhorsey

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Re: Managed Funds v ETFs - Tax implications
« Reply #3 on: June 12, 2019, 04:11:34 AM »
Thanks Marty for the heads up re: the Vanguard tax schedule.

Re: ETV v Managed Funds, I guess it's unclear to me whether the ETF is a more tax effective vehicle, so I'm a bit hesitant in swapping out my units in the Fund for the ETF until I know for sure.

My own limited experience suggests it is - but I haven't owned an ETF that is equivalent to the diversified fund I own. So I can't do a like for like comparison. And it seems like no-one in the forum has much experience - or possibly the topic is to niche or boring! Fair enough!

It does have a significant impact on the choice between ETF and Managed Fund - as I've discovered.


misterhorsey

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Re: Managed Funds v ETFs - Tax implications
« Reply #4 on: June 12, 2019, 06:27:57 PM »
Re: the Tax Schedule from Vanguard

(from Guide to your AMMA tax statement: https://static.vgcontent.info/crp/intl/auw/docs/resources/TaxGuide.pdf?20170809%7C142945)

Did you dispose of any units during the year?

If you disposed of units during the year, please be advised you will no longer receive a CGT statement and CGT guide. You can still calculate your current year’s capital gain or loss position resulting from the disposal of your Vanguard units by using information provided in your transactional history statement and information contained in the AMMA tax statement. You will need to combine any capital gain or loss you make from your disposal of any units during the year, with the capital gain information from your AMMA tax statement in completing Question 18 of your tax return.



Urgh

mjr

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Re: Managed Funds v ETFs - Tax implications
« Reply #5 on: June 13, 2019, 09:02:33 PM »
Why do think that ETFs are going to be tax advantaged compared to mutual funds ?  Underneath the ETFs are the same Vanguard mutual funds.  If the fund pays out a capital gain, owners of ETFs are going get the same gains via distributions.

Different funds will have different characteristics, sure.

mrmoonymartian

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Re: Managed Funds v ETFs - Tax implications
« Reply #6 on: June 14, 2019, 01:41:06 AM »
Why do think that ETFs are going to be tax advantaged compared to mutual funds ?  Underneath the ETFs are the same Vanguard mutual funds.  If the fund pays out a capital gain, owners of ETFs are going get the same gains via distributions.

Different funds will have different characteristics, sure.
Exhibit A1 Aus mutual fund: https://api.vanguard.com/rs/gre/gls/1.3.0/documents/7639/au
5 years (p.a.)
Income: 4.95
Growth: 2.42

Exhibit A2 VAS ETF: https://api.vanguard.com/rs/gre/gls/1.3.0/documents/7640/au
5 years (p.a.)
Income: 4.56
Growth: 2.85


Exhibit B1 Int. mutual fund: https://api.vanguard.com/rs/gre/gls/1.3.0/documents/7707/au
3 years (p.a.)
Income: 5.54
Growth: 9.08

Exhibit B2 VGS ETF: https://api.vanguard.com/rs/gre/gls/1.3.0/documents/8261/au
3 years (p.a.)
Income: 3.73
Growth: 10.88


Explanation of difference already supplied: https://www.bloomberg.com/opinion/articles/2019-05-06/vanguard-fund-investors-get-control-of-paying-taxes
"sexy tax part"
"huge structural advantage"

misterhorsey

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Re: Managed Funds v ETFs - Tax implications
« Reply #7 on: June 17, 2019, 10:34:23 PM »
Why do think that ETFs are going to be tax advantaged compared to mutual funds ?  Underneath the ETFs are the same Vanguard mutual funds.  If the fund pays out a capital gain, owners of ETFs are going get the same gains via distributions.

In short

- the Mutual Funds actually acquire ownership of the shares to reflect the index. So as they buy/sell/churn they realise capital gains/losses.

- whereas the ETFs are structured differently so that they enter into contracts with a market maker for the rights to underlying ownership in the shares, but ownership is not transferred.  So no capital gains/losses are realised as the funds managed under the ETF grows/shrinks/churns etc.

This is my very high level summary of what is discussed in the bloomberg article in the original post, and what martian man linked to as well. 

The beneficial ownership would seem to lie with the investors, or at least the benefits of ownership - so seems like a bit tax minimisation on a technicality. But I probably feel this way as I went with a Managed Fund without being aware of this issue.

marty998

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Re: Managed Funds v ETFs - Tax implications
« Reply #8 on: June 18, 2019, 04:12:28 AM »
Why do think that ETFs are going to be tax advantaged compared to mutual funds ?  Underneath the ETFs are the same Vanguard mutual funds.  If the fund pays out a capital gain, owners of ETFs are going get the same gains via distributions.

In short

- the Mutual Funds actually acquire ownership of the shares to reflect the index. So as they buy/sell/churn they realise capital gains/losses.

- whereas the ETFs are structured differently so that they enter into contracts with a market maker for the rights to underlying ownership in the shares, but ownership is not transferred.  So no capital gains/losses are realised as the funds managed under the ETF grows/shrinks/churns etc.

This is my very high level summary of what is discussed in the bloomberg article in the original post, and what martian man linked to as well. 

The beneficial ownership would seem to lie with the investors, or at least the benefits of ownership - so seems like a bit tax minimisation on a technicality. But I probably feel this way as I went with a Managed Fund without being aware of this issue.

Only when the churn is large enough (in one direction or another) are the units delivered from the market maker to Vanguard and vice-versa.

I understand the size of the "baskets" delivered or redeemed is about $1.5 million but will need to check. $1.5 million is basically the minimum parcel size to get an accurate portfolio comprising the 300 stocks in the VAS fund at the appropriate number of shares for each stock.

Or something like that. Hopefully that makes sense.