The Unexpected Christmas Present of ETF Distributions
December 24, 2008 by Ron Rowland
Filed under Commentary, ETFs
We knew it could probably happen but hoped it wouldn’t – large taxable distributions from ETFs, that is. How often have we heard that tax-efficiency is one of the major advantages of ETFs over traditional open-end mutual funds? In fact, I challenge you to show me an ETF sponsor’s website that doesn’t make this claim.
Rydex Inverse 2x S&P Select Sector Energy (REC) shocked the ETF world when it started trading “ex-dividend” on December 10, 2008 at a price that was 87% below its prior close. However, Rydex warned investors that this was going to happen. Their press release of November 25 clearly stated they anticipated large distributions for a handful of their inverse ETFs.
Perhaps no one paid attention to the original Rydex press release, so Rydex warned again on December 5. Apparently, enough investors learned in time to exit before the distribution, causing the final distribution to be more than 86% of assets versus the 74% that was originally estimated.
Then yesterday it happened again, when 35 ETFs from ProShares began trading at their post-distribution prices. ProShares announced on Monday that many of their inverse ETFs would have capital gain distributions, with the largest being the 55.8% total distribution from ProShares UltraShort Industrials (SIJ).
The creation/redemption feature of ETFs is one of the reasons that ETFs are thought to be tax efficient. However, that feature appears to break down in the case of inverse ETFs. A “traditional” plain-vanilla, long-only equity ETF has the ability to exchange ETF shares for shares of the underlying stocks and vice-versa. For inverse and leveraged inverse ETFs, that doesn’t appear to be the case. They generally hold options and swaps, making the “in-kind” redemption a much more difficult task.
Investors who are agitated at the fact that they just received a 50% taxable distribution from their ETF should note that there is a very simple solution. If an ETF (or mutual fund) you own pays out a large distribution, then the NAV/price drops by the same dollar amount. If you sell before the end of the year, then the loss from the price decline should offset the gain from the distribution.
I need to know if the etfs I hold are going to have a midyear distribution. The symbols are SKF,FAZ.SRS.DXD. and SDS. How can I get this info? And further – I need to know if they have any distributions besides the December one. Any help will be greatly appreciated. Thanks.
This type of information is usually available on the sponsor’s website. SKF normally has distributions twice a year (June & December). SDS, DXD, and SRS have quarterly ones. FAZ is too new to have a historical record but the DirexionShares website should help.