Friday, 13 April 2012

Tax Champion ETFs of 2011

A year ago we sorted through Canadian ETFs to see which left the investor with the most money after deduction of taxes on distributions. Such ETFs should be of interest for an investor looking to hold ETFs in taxable account. Let's see how they stack up this year and in particular, let's find out if last year's champions still are doing a tax-efficient job.

2011 - A banner year for tax efficient ETFs
Investors will be pleased at how much they retain after tax on distributions for the 2011 tax year according to our table below. Many ETFs allow 90 cents or more to be kept from every dollar of distributions, whether the investor is in a middle or high tax bracket. Many also sport hefty distributions.

Few fallen tax angels
Most of the highly efficient ETFs of last year are still in the table. Our gold medalist the iShares (formerly Claymore) Canadian Financial Monthly Income ETF (TSX: FIE) bears a slightly higher tax burden and is now is the silver medalist group. Several ETFs that were hot on FIE's tail last year remain high up the table and have even leapfrogged FIE e.g. iShares Dow Jones Canada Select Growth Index Fund (XCG), iShares Advantaged High Yield Bond ETF (CHB) and iShares Global Monthly Advantaged Dividend ETF (CYH).

Only five ETFs from last year's stars list have become fallen angels from the tax viewpoint: BMO Equal Weight US Health Care Hedged to CAD Index ETF (ZUH), iShares Broad Emerging Market ETF (CWO), iShares US Fundamental Index ETF (C$ Hedged) (CLU), iShares US Fundamental Index ETF (Non-hedged) (CLU.C), BMO Equal Weight REITs Index ETF (ZRE). The reason is that these ETFs distributed a lot more foreign income or ordinary income.

Wide variety of sectors amongst the tax efficient
The ETFs span a wide range of equity sectors and sub-sectors, providing plenty of choice for the investor. That equity funds would deliver tax efficiency is not surprising since distributions will naturally consist of dividends and capital gains. More surprising is that bond or fixed income funds feature among the tax efficient. Clever financial engineering enables this.

ETFs designed to transform and defer tax - Advantaged funds
Many of the ETFs in our table sport the word Advantaged in their name. These funds have been specifically designed to both defer tax and to transform returns (that may in fact be based on bond income!) into capital gains. Thus, the non-taxable Return of Capital cash distributions received are in fact deferred capital gains, which gets taxed upon sale of the investment. It is all perfectly legal, though complicated - see Canadian Couch Potato's explanation. The Advantaged funds will very likely continue to be highly tax efficient.

Tax efficiency another way - no distributions at all
The ETFs in our table all made taxable distributions but BetaPro offers a handful of ETFs that make no annual distributions and only expose the investor to capital gains deferred till eventual sale of the holding. Such ETFs would be right at the top of the tax efficiency. The ETFs are the Horizons S&P/TSX 60TM Index ETF (HXT) and the Horizons S&P 500 Index (C$ Hedged) ETF (HXS). Canadian Couch Potato did a good job analyzing how they work here.

Searching out tax efficient funds
We have compiled our table manually using the annual tax breakdown of distributions from iShares, from BMO and from Claymore (for all the funds whose trading symbol begins with "C" and FIE; Claymore recently sold their ETF business and future breakdowns will be issued by the new owner iShares). The tax character of prior year distributions going back to fund inception are found on each ETF provider's website under the Distributions tab for each ETF. A consistent past record of tax efficient distributions helps indicate what the future will be like.

A handy way to find the most efficient ETFs considering all types of distribution strategy is the TMX Money ETF Screener. The screener allows narrowing choices by asset class, region or sector amongst other variables.

As we remarked in last year's post, other important factors also come into play when assessing and deciding upon which ETF to buy: portfolio fit within a targeted asset allocation, fees and risks or potential return. It is however, very useful to know and consider the past likely future tax consequences of holding different ETFs in taxable accounts.

Disclaimer: this post is my opinion only and should not be construed as investment advice. Readers should be aware that the above comparisons are not an investment recommendation. They rest on other sources, whose accuracy is not guaranteed and the article may not interpret such results correctly. Do your homework before making any decisions and consider consulting a professional advisor.


Anonymous said...

Where can I find tax breakdown info for an ETF?
How to caluclate amount of $ kept after tax?

CanadianInvestor said...

Anon, the tax breakdown for any ETF is on the respective iShares/BMO website within its Distributions tab, though I have linked to the 2011 tables in the post. To figure out your own after-tax $$ for any ETF, go to's personal tax rates for your province and income band and subtract the tax for each time of income.

Anonymous said...

Another very helpful post, congrats ! Are you planning to build this table with 2012 results ? Thanks