IndexIQ, the Rye Brook, New York-based issuer who burst on to the scene with the launch of the first hedge fund ETFs in 2009, announced this week that it would make zero capital gains distributions for all five of its funds. IndexIQ has found a sizable market for its hedge fund replication ETFs (QAI has more than $75 million in assets) in part because of the numerous advantages these funds offer relative to traditional hedge funds.
In 2009, the hedge fund industry has endured a wave of scandals while hedge fund ETFs have racked up nearly $100 million in assets. Although they are relatively young securities without a lengthy history of returns, hedge fund ETFs have become popular because of the numerous benefits they offer relative to traditional hedge funds:
- Fees: 0.75% (or less) for ETFs vs. “2 and 20″ fees for traditional hedge funds
- Manager Risk: Tracking an index vs. trusting a manager (remember Bernie Madoff)
- Minimums: ETFs are available to almost all investors, while hedge funds are exclusive to high net worth individuals
- Withdrawal / Transaction Fees: ETF investors can close out positions at any time for only the cost of a stock trade, while hedge funds may implement redemption fees and withdrawal restrictions
- Transparency: Total transparency (ETF) vs. near total opacity (hedge fund)
- Regulation: ETFs are subject to clear regulations, while hedge funds still operate in the Wild West (little federal oversight)
The announcement of zero capital gains distributions for the year adds another bullet point to the list: hedge funds can frequently be very inefficient from a tax perspective, generating significant short-term capital gains.
Cinthia Murphy notes that “the investment strategy behind MNA could mean high portfolio turnover moving forward, which might not only lead to higher transaction costs and lower total returns to the fund, but also could expose taxable investors to capital gains distributions in the future.” The IQ ARB Merger Arbitrage ETF (MNA) invests in global companies for which there has been a public announcement of a takeover by an acquirer. Because many of these companies are ultimately acquired, the composition of MNA’s holdings could change significantly throughout the year.
Van Eck Nearly Perfect
Last week Van Eck announced that it would make capital gains distributions on just two of its 18 ETFs. The Market Vectors Brazil Small-Cap ETF (BRF) will pay short-term gains of $0.252 per share while the Vietnam ETF (VNM) will pay $0.036 per share. Index Universe reported that the distributions were related to turnover in the indexes underlying these funds — big increases in stock prices in these region caused some Brazilian companies to outgrow BRF’s upper boundaries and Vietnamese stocks to become eligible for inclusion.
Disclosure: No positions at time of writing.