ETFdb Logo
ETFdb Logo
  • ETF Database
  • Channels
    • Active ETF
    • Alternatives
    • Beyond Basic Beta
    • China Insights
    • Climate Insights
    • Commodities
    • Core Strategies
    • Crypto
    • Disruptive Technology
    • Dividend
    • Dual Impact
    • Emerging Markets
    • Energy Infrastructure
    • ESG
    • ETF Building Blocks
    • ETF Education
    • ETF Strategist
    • Fixed Income
    • Free Cash Flow
    • Future ETFs
    • Global Diversification
    • Gold & Silver Investing
    • Innovative ETFs
    • Institutional Income Strategies
    • Leveraged & Inverse
    • Managed Futures
    • Market Insights
    • Megatrends
    • Modern Alpha
    • Multi-Asset
    • Night Effect
    • Portfolio Strategies
    • Retirement Income
    • Richard Bernstein Advisors
    • Tax Efficient Income
    • Thematic Investing
    • Volatility Resource
  • Tools
    • ETF Screener
    • ETF Country Exposure Tool
    • ETF Sector Tracker Tool
    • ETF Database Categories
    • Head-To-Head ETF Comparison Tool
    • ETF Stock Exposure Tool
    • ETF Issuer Fund Flows
    • Indexes
    • Mutual Fund To ETF Converter
    • ETF Data for Journalists
    • ETF Nerds
  • Research
    • First Bitcoin ETF
    • ETF Education
    • Equity Investing
    • Dividend ETFs
    • Leveraged ETFs
    • Inverse ETFs
    • Index Education
    • Index Insights
    • Top ETF Sectors
    • Top ETF Issuers
    • Top ETF Industries
  • Webcasts
  • Themes
    • AI ETFs
    • Blockchain ETFs
    • See all Thematic Investing ETF themes
    • ESG Investing
    • Marijuana ETFs
  • Multimedia
    • ETF 360 Video Series
    • ETF Trends on Videos
    • ETF Trends on Podcasts
    • ETF Prime Podcast
  • Company
    • About Us
    • Swag Store
  • PRO
    • Pro Content
    • Pro Tools
    • Advanced
    • FAQ
    • Pricing
    • Free Sign Up
    • Login
  1. ETF Investing
  2. What Is an In-Kind Redemption for ETFs?
ETF Investing
Share

What Is an In-Kind Redemption for ETFs?

Sam BourgiMar 05, 2019
2019-03-05

New investors often envision receiving big cash payouts when they sell their securities at a profit. But what happens when the fund you are withdrawing from isn’t enjoying net inflows of capital?

This isn’t something most new investors think about when buying mutual funds or exchange-traded funds (ETFs). However, this scenario is extremely common and the process for addressing it is usually spelled out in the fund’s prospectus.

When a fund is experiencing a net outflow of capital (i.e., more redemption requests than capital inflows from new investors), investments must be sold to raise money. This is especially the case when the fund’s managers believe that honoring redemptions would endanger the investment of long-term investors who remain in the fund.

In-kind redemptions seek to address this issue by offering investors leaving the fund a payment other than cash, usually securities or other forms of property on a pro-rata basis. While this scenario describes what would happen if a fund experiences a cash crunch, exchange-traded funds are set up this way regardless of inflows. In other words, in-kind redemptions are a fundamental feature of the ETF asset class (more on that below).

The most common type of in-kind distribution occurs when a company pays a dividend in stock rather than in cash. Additionally, some funds pay out distributions in kind after a certain threshold. For example, if an investor redeems shares over the allotted threshold, the remainder of the redemption values are paid in kind, usually with shares of the fund. This lowers the tax penalty in the event of high redemption activity.

Don’t forget to check out this article to learn about the differences between an ETF and an index mutual fund.

In-Kind Redemption for ETFs

For ETFs, in-kind redemptions are the primary mechanism by which redemptions are made. When an investor wants to redeem ETF shares, the distributor usually exchanges the shares to be redeemed for a basket of securities held by the ETF. Only “authorized participants” – a form of institutional investor – may redeem shares directly from an ETF. These investors are also able to contribute securities to a fund in exchange for newly issued ETF shares. Retail investors, on the other hand, can only buy and sell ETF shares through a broker.

ETF distributions are set up this way to maximize tax efficiency and minimize capital gains distributions. According to KPMG, in-kind redemptions create “more opportunities for ETFs with appreciated and liquid portfolio holdings to defer gain recognition.”

In all cases where ETFs make in-kind redemptions, the fund never has to sell securities to generate cash. As such, it avoids generating taxable gains for non-redeeming shareholders. ETFs can also use this redemption mechanism to remove capital gains and permit non-redeeming shareholders to defer taxes on their gains.

Check out this article to learn how ETFs were made for tax-loss harvesting.

Regardless of the redemption options available to ETF managers, the in-kind mechanism proves to be more attractive in a variety of circumstances. Since many ETFs employ passive index strategies, they usually have lower turnover than actively managed funds. If a passive ETF sold securities to meet redemptions, it would create a large taxable event for non-redeeming shareholders.

The redemption mechanism is also useful when we consider investor behavior. Since investors buy ETF shares on a cost-average basis, they would be sold or redeemed for a higher amount than the cost basis. Once again, this means higher tax payments on that sale.

As KPMG also noted, over the past two decades rising markets have made it more difficult for portfolio managers to manage funds on a tax-efficient basis without using the in-kind redemption tool. In fact, selling securities with a higher cost basis is a good idea only when it is done to minimize any resulting gains.

Be sure to check our News section to keep track of the recent fund performances.


Content continues below advertisement

The Bottom Line

While the in-kind redemption mechanism can help mutual funds cover a cash crunch, they are a fundamental feature of exchange-traded funds. The tax efficiency made possible through in-kind redemptions is partially responsible for the growth and widespread adoption of ETF investing over the past 15 years.

Sign up for our free newsletter to get the latest news on ETFs.

» Popular Pages

  • Tickers
  • Articles

Jan 31

A Recap of the Night Effect in January

Jan 31

E-Commerce Spending Exceeds $1 Trillion in 2022

Jan 31

Vanguard: Fixed Income Seeing Strong Flows

Jan 31

Confluence Asset Allocation Quarterly Q1 2023

Jan 31

Embrace a “Dividend Decade” in a Quality Dividend ETF

Jan 31

ETF Prime: Disruptive Tech and International Stocks

Jan 31

Emerging Markets Ex China ETF Launched by Strive

Jan 31

QINT Catches Eyes With Quality International Equities

Jan 31

Investors Look to Equal-Weight and Quality Factors

Jan 31

Bonds Facing a Better Year: Capture With BNDI

QQQ

Invesco QQQ Trust

SPY

SPDR S&P 500 ETF Trust

VOO

Vanguard S&P 500 ETF

VGT

Vanguard Information...

SMH

VanEck Semiconductor ETF

XLK

Technology Select Sector SPDR...

VTI

Vanguard Total Stock Market...

SOXX

iShares Semiconductor ETF

BLOK

Amplify Transformational Data...

META

Roundhill Ball Metaverse ETF

Loading Articles...
Help & Info
  • Contact Us
Tools
  • ETF Screener
  • ETF Analyzer
  • Mutual Fund to ETF Converter
  • Head-To-Head ETF Comparison
  • ETF Country Exposure Tool
  • ETF Stock Exposure Tool
  • ETF Performance Visualizer
  • ETF Database Model Portfolios
  • ETF Database Realtime Ratings
  • ETF Database Pro
More Tools
  • ETF Launch Center
  • Financial Advisor & RIA Center
  • ETF Database RSS Feed
Explore ETFs
  • ETF News
  • ETF Picks of the Month
  • ETF Category Reports
  • Premium Articles
  • Alphabetical Listing of ETFs
  • Best ETFs
  • Browse ETFs by ETF Database Category
  • Browse ETFs by Index
  • Browse ETFs by Issuer
  • Compare ETFs
Legal
  • Terms of Use and Privacy Policy
  • © 2023 VettaFi LLC. All rights reserved.
Follow ETF Database
Follow ETF Database

Advertisement

Is Your Portfolio Positioned With Enough Global Exposure?

ETF Education Channel

How to Allocate Commodities in Portfolios

Tom LydonApr 26, 2022
2022-04-26

A long-running debate in asset allocation circles is how much of a portfolio an investor should...

Core Strategies Channel

Why ETFs Experience Limit Up/Down Protections

Karrie GordonMay 13, 2022
2022-05-13

In a digital age where information moves in milliseconds and millions of participants can transact...

}
X