The 7 different ETF structures


Exchange Traded Funds (ETFs) recently took a very big step: at the time of writing, ETFs now hold over $ 3 trillion in investor assets. Investors large and small continue to embrace fund type as a way of building their portfolios. And there is a lot to love about them.

However, calling them a “type of fund” is a bit misleading.

The truth is that there is more than one type of fund that makes up the ETF world, and most investors are quite unaware of the structure used by their. AND F farms.

It’s a little problem. Although the mechanism for creating / redeeming ETFs is the same, a number of different outcomes for various elements may result depending on the structure of an ETF. AND F uses – from taxes to dividend treatment. Even when two ETFs follow a similar asset class or industry, structure matters.

Fortunately, here at ETFdb, we’ve broken down the most common AND F structures and what they might mean in terms of your bottom line.

Open funds

The vast majority of ETFs fall under the open fund banner. Created by the Investment Company Act of 1940 – and protected under the Securities Act of 1933 and the Securities Exchange Act of 1934 – open-ended funds are what we traditionally think of when we talk about mutual funds.

Open funds are essentially regulated investment companies that meet certain Internal Revenue Service standards for taxes. Since the income and capital gains of flow-through entities are distributed to shareholders and taxed at shareholder level, the AND F itself does not pay taxes. Another important point about open-ended funds is that dividends and interest received from the fund’s holdings can be immediately reinvested. Derivatives, portfolio sampling and securities lending can be used in the portfolio of an open-ended fund.

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Mutual funds (ITU)

Some of the first ETFs on the market – PowerShares QQQ Confidence (QQQ A-), and the S&P 500 SPDR (TO SPY A) – are structured as mutual funds (ITU). Like open funds, ITUs fall under the 1940 Investment Companies Act. However, there are several differences between the two. Much of this difference is that ITUs do not have boards or investment advisers; they represent static investment portfolios, excellent for transparency and low costs. You know exactly what you are getting – this is why the UITs were selected by the AND F the issuers first.

However, the downsides boil down to dividends. Unlike open funds, ITU dividends cannot be reinvested, which means the fund simply holds them in cash. This can create a “cash drag” during bull markets. In addition, securities lending and derivatives cannot be used by ITUs. This may cause ITUs to underperform open versions of the same fund, albeit slightly. Technically, ITUs have a dedicated end date.

Grantor’s Trusts

Typically, ETFs that physically hold an asset are structured as grantor trusts. Often these assets are either precious metals or currencies. The popular iShares Silver Trust (SLV C +) or CurrencyShares Euro Trust (FXE A) are structured as transfer trusts, since they hold silver bars and euros in a safe on behalf of investors. The key word here is “on behalf”: Investors in cedant trusts are direct shareholders of the underlying assets, rather than the fund that owns them. As a result, investors are taxed as if they directly own the gold or currency. In the case of these two asset classes, this means that the payment of capital gains is currently taxed at a hybrid rate of 60% long-term gains and 40% short-term gains.

Limited partnerships (LPs)

Like grantor trusts, ETFs structured as limited partnerships (LPs) typically focus on commodities. But instead of physically owning gold, they use futures or other derivatives to fulfill their mandates. As far as taxes are concerned, partnerships are essentially intermediary entities that avoid double taxation at the level of the fund and the investor. The income, as well as the realized gains and losses, of a partnership AND F flow directly to investors, who then pay tax on their partnership share. The problem here is that investors may owe limited partnership taxes even if they suffer a loss on the shares, depending on the underlying investment gains inside the fund. These gains and losses will be specified on a K-1 slip – not a 1099 form – at tax time. The first declarers will have to wait, as the K-1s arrive in early March.

Exchange Traded Notes (ETN)

Exchange Traded Notes (ETNs) are a weird kind of bird when it comes to ETFs: ETNs are really bonds in disguise. These are futures contracts that promise to pay investors the performance of an index or asset class at a later date. Investors who buy a AND N become unsecured creditors of the issuing bank and must realize that ETNs carry credit risk. This means that if the issuer files for bankruptcy, investors in a AND N will have to wait in the bankruptcy queue to recover their investment.

They were originally created as a way to access hard-to-reach asset classes – master limited partnerships, emerging market currencies and stocks – since ETNs actually own nothing. They just track the returns of the underlying index with the idea of ​​providing that return to investors. ETNs will have a fixed closing date and will be liquidated when they reach that point.

C companies

In recent years, several ETFs have chosen to be taxed as C companies (C body). AC corp is essentially any corporation taxed separately from its owners. Really, 99% of all stocks traded are C bodies. In ETF terms, the structure is used as a way to provide access to Master Limited Partnerships (MLPs) and other Special Purpose Vehicles (SPVs). ). Current regulations prevent open funds and UITs from holding more than 25% of their portfolios in MLPs. By registering as a C body, ETFs can bypass regulations and own the asset class.

The problem here is that ETFs that use this structure are taxed like corporations. This means that the fund will pay taxes and then investors will pay taxes on dividends and earnings.

Managed Exchange Traded Funds (ETMFs)

The latest innovation and fund structure is what is called exchange traded managed funds. ETMFs seek to combine the active attractiveness of regular mutual funds with the intraday tradability of all others. AND F structure. ETMFs are not required to disclose their holdings daily, like regular ETFs, but quarterly, like mutual funds. Also similar to mutual funds, ETMFs will adjust their net asset value (NAV) at the end of the day. Without knowing the NAV, ETMF quotes are valued at amounts higher or lower than the potential NAV depending on supply and demand, so investors could pay more or less than NAV depending on demand.

When it comes to taxes, ETMFs should work like regular open ETFs. However, since the product is so new, the tax situation is really unknown.

The bottom line

ETFs continue to gain in popularity, but they vary in a number of ways, especially in the way they are structured. For investors, understanding how the funds they hold are legally structured can mean the difference between big wins and a nasty tax surprise.

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