ETF Heartbeat Trades, Tax Efficiencies, and Clienteles: The Role of Taxes in the Flow Migration from Active Mutual Funds to ETFs

Side‐by‐side management of mutual funds and actively managed exchange traded funds

“…Therefore, we would expect that only a subset of funds would be considered substitutes by investors. Broman and Shum (2018) and Moussawi et al (2021) document liquidity and tax clientele effects, respectively, between mutual funds and ETFs. Sherrill and Upton (2018) compare actively managed mutual funds and AMETFs, and find that the products are partial substitutes and that taxation differences also lead to clientele effects.…”

How the Closure of a U.S. Tax Loophole May Affect Investor Portfolios

“…This causes the ETF to have a greater unrealized return for holding investors. There has been recent attention, from both media ( Mider et al 2019 ) and academia ( Colon 2017 ; Hodaszy 2016 ; Moussawi et al 2021 ) on the legal and financial aspects of this benefit for ETF investors. In September 2021, U.S. Senate Finance Committee Chairman Ron Wyden released draft legislation that could mean the beginning of the end of the ETF tax loophole although the proposal is not yet part of any formal legislative plan ( Lim and Rubin 2021 ).…”

“…The ETF tax loophole is the unexpected outcome of a 1969 U.S. tax law and predates the first ETF by two decades ( Colon 2017 ). For a detailed description of how the loophole is used, we refer the reader to Colon ( 2017 ); Mider et al ( 2019 ); or Moussawi et al ( 2021 ). The ethical considerations of this loophole, as well as its implications and possible closure scenarios, have been thoroughly discussed in the academic literature, including by Hodaszy ( 2016 ), Colon ( 2017 ), and Moussawi et al ( 2021 ).…”

“…For a detailed description of how the loophole is used, we refer the reader to Colon ( 2017 ); Mider et al ( 2019 ); or Moussawi et al ( 2021 ). The ethical considerations of this loophole, as well as its implications and possible closure scenarios, have been thoroughly discussed in the academic literature, including by Hodaszy ( 2016 ), Colon ( 2017 ), and Moussawi et al ( 2021 ). While Hodaszy ( 2016 ) entertains various closure scenarios, Colon ( 2017 ) argues that the tax loophole provides an unfair tax benefit to ETFs and their investors, particularly, high-net-worth taxpayers.…”

“…While Hodaszy ( 2016 ) entertains various closure scenarios, Colon ( 2017 ) argues that the tax loophole provides an unfair tax benefit to ETFs and their investors, particularly, high-net-worth taxpayers. Moussawi et al ( 2021 ) thoroughly explore in an empirical analysis the implications and results from the tax loophole. Specifically, they find that the loophole is causing an increase in capital flow from active MFs to ETFs, and as ETF investors can defer the realization of their capital gains to an optimal future date due to the tax loophole, ETFs are becoming a more popular investment with high-net-worth investors.…”