SHEARWATER CAPITAL

Exchange-Traded Funds (ETFs)

Expert Guidance Every Step of the Way

Exchange-traded funds (ETFs) are baskets of securities, such as stocks or bonds. Unlike mutual funds, which trade once a day after the markets close, ETFs can be bought or sold throughout the trading day. Dimensional introduced ETFs in 2021 that offer diversified exposure to the market segments in which they invest, while targeting higher expected returns via innovative trading strategies and portfolio engineering.

 

ETFs can often be managed less expensively and with greater tax efficiency than mutual funds. When a mutual fund investor sells shares, the fund manager may have to sell stocks or bonds within the fund to raise cash, which can create a capital gains tax liability. ETFs, on the other hand, can rebalance their holdings through an in-kind creation and redemption process, in which authorized participants trade baskets of securities for newly created or disposed of ETF shares. When an authorized participant redeems creation units in exchange for a basket of securities, those securities are redeemed in-kind out of the ETF, which allows the fund to reduce its holdings of these securities without triggering a capital gains distribution. This allows Dimensional to reduce or eliminate realized capital gains within the ETF, thereby providing greater tax efficiency for investors.

 

Tax efficiency in Dimensional ETFs is also enhanced by minimizing portfolio turnover and paying close attention to dividend distributions. Tax-efficient management of dividend distributions results in a higher percentage of qualified dividend income (QDI), which is taxed at a lower rate than nonqualified dividend income (NQDI).

 

Another advantage of ETFs is that they can be bought or sold with no trading fee on most institutional platforms, thereby avoiding the trading fee applied to mutual funds. There are other trading costs to consider, such as bid/ask spreads and market impact; however, we strive to minimize these costs by using limit orders and a careful approach to trading.