Mutual Funds and Capital Gains Taxes

Observant1

Vanguard designed a process which eliminated capital gains distributions for select equity index mutual funds.
They basically added an ETF share class to an existing index mutual fund and used so-called heartbeat trades.
These trades rapidly pump money into/out of the ETF to wash away taxes for mutual fund shareholders.
Vanguard is the only firm using this innovation - they were awarded a patent in 2001 which is valid until 2023.
Other firms may copy this when the patent expires.
More detailed info here.


Edit: Added "equity" before "index mutual funds".

yogibearbull

Markets also cooperated by being mostly in bullish trend leading to fund inflows. Remember, VG has been the king of fund inflows.

Flipside of the connection between VG OEFs and ETFs is that when there were large redemptions/outflows in 2020 (and in any other years), both the VG OEF and the related VG ETF had similar CG distributions. See the short table below.

Self-standing non-VG bond ETFs didn't have this issue. Much of the benefit from the ETF structure is from the combination of indexing and nontaxable in-kind trading. There are some additional benefits from the VG patented structure of having OEF and ETF classes. VG didn't license its patent to anybody else and others didn't really beg VG for that license. But things may change in/after 2023.

2020 CGs for several VG bond funds

VEDTX /EDV 3.16%
VBLAX /BLV 2.69%
VBILX /BIV 0.71%
VSIGX /VGIT 0.71%
VSBSX /VGSH 0.60%

Observant1

Vanguard's domestic equity index mutual funds with an ETF share class are listed below ¹.

Vanguard 500 Index (VFIAX)
Vanguard Dividend Appreciation Index (VDADX)
Vanguard Extended Market Index (VEXAX)
Vanguard Growth Index Fund (VIGAX)
Vanguard High Dividend Yield Index (VHYAX)
Vanguard Large-Cap Index (VLCAX)
Vanguard Mid-Cap Growth Index (VMGMX)
Vanguard Mid-Cap Index (VIMAX)
Vanguard Mid-Cap Value Index (VMVAX)
Vanguard Small-Cap Growth Index (VSGAX)
Vanguard Small-Cap Index (VSMAX)
Vanguard Small-Cap Value Index (VSIAX)
Vanguard Total Stock Market Index (VTSAX)
Vanguard Value Index (VVIAX)

After the corresponding ETF share class was added,
there were no capital gains distributions for these funds.

Note: I haven't researched fixed-income index mutual funds or
international index mutual funds from Vanguard.


¹ excludes institutional funds.

Gary1952

yogibearbull said:

Markets also cooperated by being mostly in bullish trend leading to fund inflows. Remember, VG has been the king of fund inflows.

Flipside of the connection between VG OEFs and ETFs is that when there were large redemptions/outflows in 2020 (and in any other years), both the VG OEF and the related VG ETF had similar CG distributions. See the short table below.

Self-standing non-VG bond ETFs didn't have this issue. Much of the benefit from the ETF structure is from the combination of indexing and nontaxable in-kind trading. There are some additional benefits from the VG patented structure of having OEF and ETF classes. VG didn't license its patent to anybody else and others didn't really beg VG for that license. But things may change in/after 2023.

2020 CGs for several VG bond funds

VEDTX /EDV 3.16%
VBLAX /BLV 2.69%
VBILX /BIV 0.71%
VSIGX /VGIT 0.71%
VSBSX /VGSH 0.60%

So how does this help me? Do I want to own the ETF or OEF?

yogibearbull

Well, the general takeaway is that broad market VG ETFs are fine (SP500, total stock market, etc) but in specialized or illiquid areas (sectors, EMs, bonds, etc), VG ETFs may surprise with unexpected CGs due to their structural tie-ins with VG OEFs. That is, those VG OEFs and ETFs will be equally impacted by fund flows (especially, outflows). In these areas, self-standing ETFs from others may be better.