Swap Mutual Funds for ETFs?

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ruralavalon
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Re: Swap Mutual Funds for ETFs?

Post by ruralavalon »

Nowizard wrote: Wed Jun 16, 2021 9:00 am To some extent, where the funds are located is an issue. Other than expense differences, if any, assets in retirement funds will be taxed on amounts of withdrawals rather than on added dividends and capital gains.

Tim
The OP said the funds are in a taxable brokerage account at Chase, "small gain so far, maybe a few %, which would be a few thousand Dollars. Currently just into the top tax bracket."
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Re: Swap Mutual Funds for ETFs?

Post by HootingSloth »

alex_686 wrote: Wed Jun 16, 2021 7:54 am Is a 2 basis point expense ratio advantage decisive for the customer. Nope, and I said that up stream. If you were in Vanguard's shoes would you consider a 25% to 50% reduction in expenses decisive? Note, not all expenses make it into the expense ratio.
If I were in Vanguard's shoes, I don't know that I would consider it decisive if my customers were willing to bear the increased costs through a higher expense ratio on the mutual fund shares and if they would complain about being forced into ETFs. If I were in my own shoes, I would gladly bear those costs for the convenience of using a mutual fund and would be ticked off if the mutual fund were discontinued in favor of ETFs only. Maybe there won't be enough people like me in the long run, but I'm not sure of it.

In any event, if and when it happens, it seems extremely likely that a tax-free conversion option will still be available. It's hard to make a case for making a preemptive change.
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Re: Swap Mutual Funds for ETFs?

Post by alex_686 »

Gaston wrote: Wed Jun 16, 2021 8:19 am
alex_686 wrote: Wed Jun 16, 2021 7:54 am Go back to the 50s. Closed end funds dominated open ended funds. Closed end funds are still around, but at a fraction of their former glory.
Trivia: One of the podcast guys I listened to said that closed-end funds were the first ETFs. They were funds (collections of company stocks), and they were traded on an exchange, so they quite literally were exchange-traded funds.

Today, most of us think of ETFs as index-tracking investments, but in fact many actively-managed ETFs exist.
I would strongly disagree with that statement. There is the similarity that both trade on a exchange, but I think that is superficial. Would you care to expand?

ETFS and mutual funds - both open and closed ended - fall under the same general regulations. As such they share a lot of the same basic characteristics.

But the way that these 3 products are also distinctly different. I can't see why a actively managed ETF is closer to a closed end mutual fund than to a open ended mutual fund.
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Re: Swap Mutual Funds for ETFs?

Post by alex_686 »

HootingSloth wrote: Wed Jun 16, 2021 9:43 am
alex_686 wrote: Wed Jun 16, 2021 7:54 am Is a 2 basis point expense ratio advantage decisive for the customer. Nope, and I said that up stream. If you were in Vanguard's shoes would you consider a 25% to 50% reduction in expenses decisive? Note, not all expenses make it into the expense ratio.
If I were in Vanguard's shoes, I don't know that I would consider it decisive if my customers were willing to bear the increased costs through a higher expense ratio on the mutual fund shares and if they would complain about being forced into ETFs. If I were in my own shoes, I would gladly bear those costs for the convenience of using a mutual fund and would be ticked off if the mutual fund were discontinued in favor of ETFs only. Maybe there won't be enough people like me in the long run, but I'm not sure of it.

In any event, if and when it happens, it seems extremely likely that a tax-free conversion option will still be available. It's hard to make a case for making a preemptive change.
I assume you have heard of the "first mover advantage", where the first player into the field gets to set the rules. There is also something called the "first mover disadvantage", where the first players - and their customers - get locked into a older technology.

So let us talk about market structure.

1. The larger a fund is the lower its expenses are. Or to be more explicate, the lower the tracking error is.

2. Index funds are a commodity. It is price that determines the winner, not customer service.

3. As such, for any particular sector only a few big names dominate.

Vanguard faces a problem. It has a higher cost structure than its competitors. Does it alienate current customers with a conversion to ETFs, or does it lose future business because of a higher cost structure. It is going to be a balancing act.
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eukonomos
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Re: Swap Mutual Funds for ETFs?

Post by eukonomos »

Onlineid3089 wrote: Tue Jun 15, 2021 1:34 pm I prefer mutual funds because I like my monthly contribution to be automated, and it is my understanding that I can't do that with ETFs. I still might convert my VTSAX to VTI in the next few months as I'll cross 100,000 in that account as long as the market doesn't tank, just for the ability to transfer it to Merrill Edge so I could take out the Bank of America rewards card with the platinum honors benefits.

From a behavioral standpoint, I think mutual funds are better for me. I prefer automated investing. I also think I'd stress way too much over market fluctuations on the days that I'd make investments.
Why not transfer VTSAX to Merrill Edge? Future purchases there would have a fee, but not dividend reinvestments as I understand it. New purchases could be made in the account at Vanguard.

If you transfer $100K+ to ME and get to platinum honors, then the market drops you below 100K, I think you have a one year grace period to get back to 100K.
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Re: Swap Mutual Funds for ETFs?

Post by HootingSloth »

alex_686 wrote: Wed Jun 16, 2021 10:20 am
HootingSloth wrote: Wed Jun 16, 2021 9:43 am
alex_686 wrote: Wed Jun 16, 2021 7:54 am Is a 2 basis point expense ratio advantage decisive for the customer. Nope, and I said that up stream. If you were in Vanguard's shoes would you consider a 25% to 50% reduction in expenses decisive? Note, not all expenses make it into the expense ratio.
If I were in Vanguard's shoes, I don't know that I would consider it decisive if my customers were willing to bear the increased costs through a higher expense ratio on the mutual fund shares and if they would complain about being forced into ETFs. If I were in my own shoes, I would gladly bear those costs for the convenience of using a mutual fund and would be ticked off if the mutual fund were discontinued in favor of ETFs only. Maybe there won't be enough people like me in the long run, but I'm not sure of it.

In any event, if and when it happens, it seems extremely likely that a tax-free conversion option will still be available. It's hard to make a case for making a preemptive change.
I assume you have heard of the "first mover advantage", where the first player into the field gets to set the rules. There is also something called the "first mover disadvantage", where the first players - and their customers - get locked into a older technology.

So let us talk about market structure.

1. The larger a fund is the lower its expenses are. Or to be more explicate, the lower the tracking error is.

2. Index funds are a commodity. It is price that determines the winner, not customer service.

3. As such, for any particular sector only a few big names dominate.

Vanguard faces a problem. It has a higher cost structure than its competitors. Does it alienate current customers with a conversion to ETFs, or does it lose future business because of a higher cost structure. It is going to be a balancing act.
For what it is worth, I am in my mid-30s, so always had the choice between mutual funds and ETFs and gladly chose mutual funds at a slightly higher cost. I started out using ETFs but switched over to mutual funds when I was able to do so through tax loss harvesting. I find ETFs very unpleasant to deal with and would probably pay a fair amount more than 2 basis points to avoid having to do so. Given that all the kids these days like to say "VTSAX and chill," rather than 'VTI and chill," I don't think preferences for mutual funds by some customers is a phenomenon driven by older investors being set in their ways, or anything like that. Instead, I would guess that many just prefer to pay slightly more for what, in their eyes at least, is a much better service. I also don't feel any impulse to switch over to Fidelity or any of Vanguard's competitors, even in my tax advantaged accounts, and the saying has not become "FZROX and chill" either.

What you are saying is certainly one possible future. However, I would have thought that, for a large player like Vanguard, one way to cope with the "balancing act" is just to offer both an ETF and a mutual fund version of the same funds, to charge slightly more for the mutual fund version, and to see what customers choose. That seems to be what Vanguard started doing in 2019.
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Re: Swap Mutual Funds for ETFs?

Post by alex_686 »

HootingSloth wrote: Wed Jun 16, 2021 10:55 am What you are saying is certainly one possible future. However, I would have thought that, for a large player like Vanguard, one way to cope with the "balancing act" is just to offer both an ETF and a mutual fund version of the same funds, to charge slightly more for the mutual fund version, and to see what customers choose. That seems to be what Vanguard started doing in 2019.
I am highly confident that this is the future. The writing is on the wall. I may be wrong about the timing.

There are advantages and disadvantages to the hybrid system. I think Vanguard is about at the inflection point where the disadvantages are greater than the advantages. A higher expense ratio for the mutual fund class can't offset the higher trading costs that would spill over to the ETF class. It is like strapping on a 20 pound backpack to Usain Bolt. Still darn fast, but that handicap would probably prevent him from medaling.
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Re: Swap Mutual Funds for ETFs?

Post by Onlineid3089 »

eukonomos wrote: Wed Jun 16, 2021 10:30 am
Onlineid3089 wrote: Tue Jun 15, 2021 1:34 pm I prefer mutual funds because I like my monthly contribution to be automated, and it is my understanding that I can't do that with ETFs. I still might convert my VTSAX to VTI in the next few months as I'll cross 100,000 in that account as long as the market doesn't tank, just for the ability to transfer it to Merrill Edge so I could take out the Bank of America rewards card with the platinum honors benefits.

From a behavioral standpoint, I think mutual funds are better for me. I prefer automated investing. I also think I'd stress way too much over market fluctuations on the days that I'd make investments.
Why not transfer VTSAX to Merrill Edge? Future purchases there would have a fee, but not dividend reinvestments as I understand it. New purchases could be made in the account at Vanguard.

If you transfer $100K+ to ME and get to platinum honors, then the market drops you below 100K, I think you have a one year grace period to get back to 100K.
I might need to consider that and look into it if/when I get to the point of . Future contributions will still be made at Vanguard to VTSAX. I just don't want to run into any scenario where I'd end up paying anything to hold VTSAX at Merrill Edge instead of VTI. Maybe it would be a non-issue that I shouldn't be worried about.
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Re: Swap Mutual Funds for ETFs?

Post by HootingSloth »

alex_686 wrote: Wed Jun 16, 2021 11:14 am
HootingSloth wrote: Wed Jun 16, 2021 10:55 am What you are saying is certainly one possible future. However, I would have thought that, for a large player like Vanguard, one way to cope with the "balancing act" is just to offer both an ETF and a mutual fund version of the same funds, to charge slightly more for the mutual fund version, and to see what customers choose. That seems to be what Vanguard started doing in 2019.
I am highly confident that this is the future. The writing is on the wall. I may be wrong about the timing.

There are advantages and disadvantages to the hybrid system. I think Vanguard is about at the inflection point where the disadvantages are greater than the advantages. A higher expense ratio for the mutual fund class can't offset the higher trading costs that would spill over to the ETF class. It is like strapping on a 20 pound backpack to Usain Bolt. Still darn fast, but that handicap would probably prevent him from medaling.
Maybe I am missing something. Why can't Vanguard pass along the higher trading costs only to mutual fund investors by raising their expense ratio by the amount of the excess trading costs and lowering the ETF class expense ratio by an offsetting amount? Are they not free to do this, or is it too hard to estimate for some reason? Would doing this not give the ETF investors the same return that they would have received if the mutual fund class did not exist?
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Re: Swap Mutual Funds for ETFs?

Post by nisiprius »

Gaston wrote: Wed Jun 16, 2021 8:19 am
alex_686 wrote: Wed Jun 16, 2021 7:54 am Go back to the 50s. Closed end funds dominated open ended funds. Closed end funds are still around, but at a fraction of their former glory.
Trivia: One of the podcast guys I listened to said that closed-end funds were the first ETFs. They were funds (collections of company stocks), and they were traded on an exchange, so they quite literally were exchange-traded funds.

Today, most of us think of ETFs as index-tracking investments, but in fact many actively-managed ETFs exist.
Yes, and that is a fairly recent development. I'm trying to remember when the regulations changed to allow actively managed ETFs. And, yeah, personally I view that with alarm.

"Most of us" think of ETFs as low-cost investment vehicles, too, and that, too is antiquated. But I'll bet a lot of literature purporting to explain ETFs to new investors probably still calls them "low-cost."

I would even go so far as to say that most of the hot trendy new ETFs have expense ratios over 0.50%. Let me think. Just ones mentioned lately in the forum.

BOND (PIMCO's bond ETF) 0.55%
QYLD, Nasdaq 100 covered calls, 0.60%
NUSI (Nationwide Risk-Managed Income) 0.68%
ARKK (OK, it hasn't been mentioned all that lately[/i]), 0.75%
BFEB and other Innovator Power Buffer ETFs 0.79%
Tuttle FOMO ETF 0.80%
EMQQ The Emerging Markets Internet & Ecommerce ETF 0.88%
UPRO 0.93%

Uniqueness and novelty count for everything, expenses count for nothing, and we are hearing all the same blarney we used to hear about mutual funds--the expenses are little bit high but not in relation to what you are getting for it, and stated returns are net of expenses so why would you care about expenses if I can make you more :moneybag :moneybag :moneybag, etc etc.
Last edited by nisiprius on Wed Jun 16, 2021 3:44 pm, edited 1 time in total.
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Re: Swap Mutual Funds for ETFs?

Post by alex_686 »

HootingSloth wrote: Wed Jun 16, 2021 11:25 am Maybe I am missing something. Why can't Vanguard pass along the higher trading costs only to mutual fund investors by raising their expense ratio by the amount of the excess trading costs and lowering the ETF class expense ratio by an offsetting amount? Are they not free to do this, or is it too hard to estimate for some reason? Would doing this not give the ETF investors the same return that they would have received if the mutual fund class did not exist?
They can't do it.

First, let us start off with that the fund is a single vast pool of money and assets. The portfolio managers execute trades for that vast pool of money. You might be able to designate some trades for a specific share class but most are going to be comingled. Mutual funds have to trade to balance in inflows and outflows of cash. They will have some cash drag because they create/redeem shares after the market is closed.

Second, most trading costs are implicit. Commissions can be tracked because it is a explicated number. The impact of the bid/ask spread can only be estimated. It can be either positive or negative. ETFs on the other hand can ignore the bid/ask spread. The index says X shares of VTI should have Y shares of Apple. The authorized participants have to deliver Y shares of Apple. It is the AP shares who have to deal with the bid/ask spread.

Lets say the impact of this tracking error is 1 to 4 bps. VTI's expense ratio is 3 bps. Would you classify this impact as large or small? Relative speaking I would classify this as large looking at this from either Vanguard's or from a intuitional investor's standpoint.

Now, lets say that Vanguard could estimate this cost. They still can't pass it along.

Expense ratios only included explicate costs. It is one of the reasons why trading expenses are excluded from the expense ratio. This is SEC regulation.
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Re: Swap Mutual Funds for ETFs?

Post by HootingSloth »

alex_686 wrote: Wed Jun 16, 2021 11:57 am Now, lets say that Vanguard could estimate this cost. They still can't pass it along.

Expense ratios only included explicate costs. It is one of the reasons why trading expenses are excluded from the expense ratio. This is SEC regulation.
Could you provide a citation or point to something describing these SEC rules? Do active mutual funds and ETFs really limit their higher expense ratios to explicit costs under these rules? They are not allowed to increase them to provide profit/compensation for the management services they are providing?

Obviously, it is permissible under the SEC rules for there to be implicit trading costs that are not included in the expense ratio that is disclosed to investors, but that is not the same as saying that an expense ratio cannot be increased or decreased to effectively pass along (or offset) these implicit costs.
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Re: Swap Mutual Funds for ETFs?

Post by AK59 »

22twain wrote: Wed Jun 16, 2021 5:37 am
AK59 wrote: Wed Jun 16, 2021 2:48 am What about going from mutual fund to mutual fund?
You have to sell the first fund, thereby realizing the (taxable) capital gains, and then buy the second one. Vanguard (along with most other brokers) probably has an "exchange" option which combines the two steps into one for convenience, but from the IRS point of view it's still "sell then buy."
Correct, they do have an exchange button. So if Vanguard still sees it as sell/buy and you are realizing the capital gains they would still be subject to tax, correct? There really is no way to do a direct mutual fund transfer without being taxed to my understanding?
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Re: Swap Mutual Funds for ETFs?

Post by iceport »

alex_686 wrote: Wed Jun 16, 2021 11:57 am
HootingSloth wrote: Wed Jun 16, 2021 11:25 am Maybe I am missing something. Why can't Vanguard pass along the higher trading costs only to mutual fund investors by raising their expense ratio by the amount of the excess trading costs and lowering the ETF class expense ratio by an offsetting amount? Are they not free to do this, or is it too hard to estimate for some reason? Would doing this not give the ETF investors the same return that they would have received if the mutual fund class did not exist?
They can't do it.
Then what mechanism allows Vanguard to charge more for some mutual fund shares than for their identical ETF twin shares? And to slap on purchase/redemption fees for some mutual funds but not their ETF twins?
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Re: Swap Mutual Funds for ETFs?

Post by iceport »

AK59 wrote: Wed Jun 16, 2021 12:27 pm
22twain wrote: Wed Jun 16, 2021 5:37 am
AK59 wrote: Wed Jun 16, 2021 2:48 am What about going from mutual fund to mutual fund?
You have to sell the first fund, thereby realizing the (taxable) capital gains, and then buy the second one. Vanguard (along with most other brokers) probably has an "exchange" option which combines the two steps into one for convenience, but from the IRS point of view it's still "sell then buy."
Correct, they do have an exchange button. So if Vanguard still sees it as sell/buy and you are realizing the capital gains they would still be subject to tax, correct? There really is no way to do a direct mutual fund transfer without being taxed to my understanding?

Correct. :thumbsup

(Other than being upgraded from the old Investor share classes to Admiral. That was not a taxable conversion, though the shares prices and number of shares differ before and after the conversion.)
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Re: Swap Mutual Funds for ETFs?

Post by alex_686 »

HootingSloth wrote: Wed Jun 16, 2021 12:06 pm Could you provide a citation or point to something describing these SEC rules?
I think Google is your friend here. I don't have time to this. However, I was in mutual fund accounting for 10 years.
HootingSloth wrote: Wed Jun 16, 2021 12:06 pm Do active mutual funds and ETFs really limit their higher expense ratios to explicit costs under these rules? They are not allowed to increase them to provide profit/compensation for the management services they are providing?
Going deep into the weeds here, but no. You are framing the question wrong.

A fund will have a trading desk. Traders, computers, fancy data links. etc. This is a explicate cost and is allocated to the fund.

The portfolio manager puts in a trade with the traders.

The trade has costs, both explicate (maybe) and implicit. Neither of these costs are included in the expense ratio. Note, many trades are done on a principal basis. The fund does not hire a broker for the trade. Rather they talk directly to another trading desk and buy it from them. There is no commission cost here. Still a implicit cost.

For public funds (both mutual and ETFs) the trade must chose best execution. The trader is acting as a fiduciary for the fund. They must chose "best execution". They may chose a expensive brokerage to execute the trade if they feel that the benefits outweigh the cost. Speed, ability to complete, low implicit costs on the bid/ask spread. etc.

Since the trader is acting on behalf of the fund they can't benefit from a trade. Some brokers kick back a portion of the trade costs in "soft dollars". These soft dollars belong to the fund, not anybody else.
HootingSloth wrote: Wed Jun 16, 2021 12:06 pm Obviously, it is permissible under the SEC rules for there to be implicit trading costs that are not included in the expense ratio that is disclosed to investors, but that is not the same as saying that an expense ratio cannot be increased or decreased to effectively pass along (or offset) these implicit costs.
It is. I am not even sure how your suggestion would work. A fund can't charge a fee and not disclose it. But are you suggesting that the fund charge the mutual fund class a estimate trading fee and then hand that over to the ETF class? This is not allowed. The only way for a fund to collect expenses is to directly attribute those expenses to - well - a specific direct expense. Plus, one share class can't subsidize another share class.
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Re: Swap Mutual Funds for ETFs?

Post by iceport »

alex_686 wrote: Wed Jun 16, 2021 11:14 am I am highly confident that this [mutual funds being phased out and share holders being forced into ETFs] is the future. The writing is on the wall. I may be wrong about the timing.
You may be correct, and your timing may or may not be correct, but this is the first time I've seen such a hypothesis be woven into a recommendation, as justification, to change a taxable holding from a mutual fund to an ETF.

To be fair, your first post here preceded the OP's subsequent note that the change would incur somewhere in the neighborhood of a $1000.00 tax bill.

But even absent that knowledge, given how sketchy the prediction is, and how unlikely it seems that investors would all be forced to eat huge capital gains tax bills to make the change on a widespread or global basis, it seems to me that such an assertion should be heavily qualified — to the point where it probably shouldn't be entering into the decision-making process at all until we get closer to that reality and the circumstances become clearer.

Just my 2 cents.
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Re: Swap Mutual Funds for ETFs?

Post by alex_686 »

iceport wrote: Wed Jun 16, 2021 12:29 pm
alex_686 wrote: Wed Jun 16, 2021 11:57 am
HootingSloth wrote: Wed Jun 16, 2021 11:25 am Maybe I am missing something. Why can't Vanguard pass along the higher trading costs only to mutual fund investors by raising their expense ratio by the amount of the excess trading costs and lowering the ETF class expense ratio by an offsetting amount? Are they not free to do this, or is it too hard to estimate for some reason? Would doing this not give the ETF investors the same return that they would have received if the mutual fund class did not exist?
They can't do it.
Then what mechanism allows Vanguard to charge more for some mutual fund shares than for their identical ETF twin shares? And to slap on purchase/redemption fees for some mutual funds but not their ETF twins?
You can only charge specific share class expenses for direct expenses those fund occur.

As a specific example, we would take the printing and postage cost of mailing out the statements, annual reports, etc. and allocate those costs to those funds. Lots of long meetings on how best to combine annual reports to minimize costs for all.

Another specific example are tax filings and audits. You file taxes at the fund level. Everybody pays the same since they all get the same benefit.

The ETF part misses the mark. When you buy and sell a ETF you are interacting with another investor. Not Vanguard. As such, Vanguard does not bear the cost of the trading. Since it is not a cost it is not a expense. Vanguard can charge extra to the Authorized Participants for the creation & redemption of shares, but that cost is born by the AP. Once again, no expenses to Vanguard so it is not part of the expense ratio.
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Re: Swap Mutual Funds for ETFs?

Post by HootingSloth »

alex_686 wrote: Wed Jun 16, 2021 12:42 pm
HootingSloth wrote: Wed Jun 16, 2021 12:06 pm Could you provide a citation or point to something describing these SEC rules?
I think Google is your friend here. I don't have time to this. However, I was in mutual fund accounting for 10 years.
HootingSloth wrote: Wed Jun 16, 2021 12:06 pm Do active mutual funds and ETFs really limit their higher expense ratios to explicit costs under these rules? They are not allowed to increase them to provide profit/compensation for the management services they are providing?
Going deep into the weeds here, but no. You are framing the question wrong.

A fund will have a trading desk. Traders, computers, fancy data links. etc. This is a explicate cost and is allocated to the fund.

The portfolio manager puts in a trade with the traders.

The trade has costs, both explicate (maybe) and implicit. Neither of these costs are included in the expense ratio. Note, many trades are done on a principal basis. The fund does not hire a broker for the trade. Rather they talk directly to another trading desk and buy it from them. There is no commission cost here. Still a implicit cost.

For public funds (both mutual and ETFs) the trade must chose best execution. The trader is acting as a fiduciary for the fund. They must chose "best execution". They may chose a expensive brokerage to execute the trade if they feel that the benefits outweigh the cost. Speed, ability to complete, low implicit costs on the bid/ask spread. etc.

Since the trader is acting on behalf of the fund they can't benefit from a trade. Some brokers kick back a portion of the trade costs in "soft dollars". These soft dollars belong to the fund, not anybody else.
HootingSloth wrote: Wed Jun 16, 2021 12:06 pm Obviously, it is permissible under the SEC rules for there to be implicit trading costs that are not included in the expense ratio that is disclosed to investors, but that is not the same as saying that an expense ratio cannot be increased or decreased to effectively pass along (or offset) these implicit costs.
It is. I am not even sure how your suggestion would work. A fund can't charge a fee and not disclose it. But are you suggesting that the fund charge the mutual fund class a estimate trading fee and then hand that over to the ETF class? This is not allowed. The only way for a fund to collect expenses is to directly attribute those expenses to - well - a specific direct expense. Plus, one share class can't subsidize another share class.
Unfortunately, my Google skills may not be sufficiently strong, as I have not been able to find any SEC rules referencing the "explicate costs" terminology that you keep using. This document appears to suggest that a fund may choose between either "cover[ing] the costs associated with your transactions and your account by imposing fees and charges directly on you at the time of the transactions (or periodically with respect to account fees)" or "pay[ing] their regular and recurring fund-wide operating expenses out of fund assets, instead of imposing these fees and charges directly on you."

I also found an SEC proposal about whether mutual funds should be required to disclose their trading costs to investors. The proposal notes that these amounts already "must be disclosed to a fund's board of directors where such costs bear on the reasonableness of the fund's payments to the fund manager or its affiliates." That suggests to me that funds should be able to roughly estimate these costs, although the proposal describes some of the challenges in quantifying various implicit costs.

I have not yet found anything saying that a fund cannot create an explicit charge that applies to only one share class that would allow holders of that share class to internalize the implicit costs that they have specifically created for a fund. Perhaps it is not permissible, but I would find it interesting to hear a securities lawyer's perspective on this.
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alex_686
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Re: Swap Mutual Funds for ETFs?

Post by alex_686 »

HootingSloth wrote: Wed Jun 16, 2021 1:30 pm I also found an SEC proposal about whether mutual funds should be required to disclose their trading costs to investors. The proposal notes that these amounts already "must be disclosed to a fund's board of directors where such costs bear on the reasonableness of the fund's payments to the fund manager or its affiliates." That suggests to me that funds should be able to roughly estimate these costs, although the proposal describes some of the challenges in quantifying various implicit costs.

I have not yet found anything saying that a fund cannot create an explicit charge that applies to only one share class that would allow holders of that share class to internalize the implicit costs that they have specifically created for a fund. Perhaps it is not permissible, but I would find it interesting to hear a securities lawyer's perspective on this.
For context, the SEC has a strong preference that publicly reported numbers are "hard". So not just explicate costs, but values where all funds are using the same methodology so investors can make a true apples to apples comparison. Also, values that can't be gamed. Trading expenses fail both of these.

Boards should review trading expenses, but it is not a nuanced thing that can be boiled down to simple numbers.

They also like observable values generated by independent agents, can be validated by 3rd parties, can be audited 7 years after the fact.
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Re: Swap Mutual Funds for ETFs?

Post by HootingSloth »

alex_686 wrote: Wed Jun 16, 2021 1:44 pm
HootingSloth wrote: Wed Jun 16, 2021 1:30 pm I also found an SEC proposal about whether mutual funds should be required to disclose their trading costs to investors. The proposal notes that these amounts already "must be disclosed to a fund's board of directors where such costs bear on the reasonableness of the fund's payments to the fund manager or its affiliates." That suggests to me that funds should be able to roughly estimate these costs, although the proposal describes some of the challenges in quantifying various implicit costs.

I have not yet found anything saying that a fund cannot create an explicit charge that applies to only one share class that would allow holders of that share class to internalize the implicit costs that they have specifically created for a fund. Perhaps it is not permissible, but I would find it interesting to hear a securities lawyer's perspective on this.
For context, the SEC has a strong preference that publicly reported numbers are "hard". So not just explicate costs, but values where all funds are using the same methodology so investors can make a true apples to apples comparison. Also, values that can't be gamed. Trading expenses fail both of these.

Boards should review trading expenses, but it is not a nuanced thing that can be boiled down to simple numbers.

They also like observable values generated by independent agents, can be validated by 3rd parties, can be audited 7 years after the fact.
Thanks for your perspective. I will watch with interest as the mutual fund/ETF battle for market share plays out.
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Re: Swap Mutual Funds for ETFs?

Post by UpperNwGuy »

Meanwhile, I plan to keep investing in my Vanguard mutual funds in my Vanguard brokerage account. I'll start investing in ETFs only when it is absolutely necessary. I am confident that any future decision by Vanguard to force me into ETFs will include a means to convert my mutual funds to ETFs as a non-taxable event.
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Re: Swap Mutual Funds for ETFs?

Post by HootingSloth »

UpperNwGuy wrote: Wed Jun 16, 2021 2:06 pm Meanwhile, I plan to keep investing in my Vanguard mutual funds in my Vanguard brokerage account. I'll start investing in ETFs only when it is absolutely necessary. I am confident that any future decision by Vanguard to force me into ETFs will include a means to convert my mutual funds to ETFs as a non-taxable event.
That seems like a good decision. I will be doing the same.
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Re: Swap Mutual Funds for ETFs?

Post by AnEngineer »

alex_686 wrote: Tue Jun 15, 2021 2:30 pm
sycamore wrote: Tue Jun 15, 2021 1:41 pm
alex_686 wrote: Tue Jun 15, 2021 10:48 am ...Mutual funds distribute capital gains as dividends each year. ETFs do not.
Sorry to nitpick but "Mutual funds distribute capital gains as dividends" doesn't make sense. I've had mutual funds that distribute capital gains and they're listed as such on my transaction history, not as dividends. Even ETFs that do distribute capital gains (like Total Bond Market / BND https://investor.vanguard.com/etf/profi ... utions/bnd) list the distributions as LT Cap Gain and ST Cap Gain.

Was that just a typo and the "as dividends" part wasn't intended?
Not a typo. All funds must distribute all income each year. They do this as dividends. Now, the dividends may be coded as income. This is the default so everybody thinks of these as the same - but they are not. Or the dividends can be coded at LT Cap Gains, ST Cap Gains, or whatever. But they all get pipped through the dividend payment system.

For context, I used to work in mutual fund accounting sending these out and brokerage operations where we received them.
Do cap gains dividends count as cap gains for the purposes of offsetting capital losses?
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Re: Swap Mutual Funds for ETFs?

Post by AnEngineer »

nisiprius wrote: Tue Jun 15, 2021 11:27 am 2) In exchange for that greater control, you also lose some control, for example on when you can place an order. It is unwise to place an ETF order outside of market hours. During market hours, you possibly need to keep paying attention to a screen to choose the moment to place the trade... and perhaps keep following after the trade to see if it went through. When I was working, I always felt this was slightly inconsiderate to my employer.
Why are ETFs different than MFs after hours? The market is closed and you don't know the price you'll get in either case.
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Re: Swap Mutual Funds for ETFs?

Post by AnEngineer »

DB2 wrote: Tue Jun 15, 2021 5:58 pm My biggest fear with ETFs is...making that sell and getting flash crashed (thinking what happened to Apple stock in 2012) or something extremely odd and rare happening not in my favor.
This is completely avoided by using limit orders with ETFs, whereas you cannot avoid the risk of this with MFs.
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Re: Swap Mutual Funds for ETFs?

Post by livesoft »

AnEngineer wrote: Wed Jun 16, 2021 6:37 pmDo cap gains dividends count as cap gains for the purposes of offsetting capital losses?
On a Form 1099-DIV, the capital gains listed in Box 2a, get reported on Form 1040 Schedule D Line 13, but these are Long-Term Capital Gains and get treated as realized long-term capital gains.

The short-term capital gains distributions are included in Form 1099-DIV Box 1a and do not get to be offset with realized capital losses (or previous carryover losses) unless one considers net capital losses up to $3,000 that offset ordinary income as offsetting them.
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Re: Swap Mutual Funds for ETFs?

Post by DB2 »

AnEngineer wrote: Wed Jun 16, 2021 6:44 pm
DB2 wrote: Tue Jun 15, 2021 5:58 pm My biggest fear with ETFs is...making that sell and getting flash crashed (thinking what happened to Apple stock in 2012) or something extremely odd and rare happening not in my favor.
This is completely avoided by using limit orders with ETFs, whereas you cannot avoid the risk of this with MFs.
How are MFs more risky here?
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Re: Swap Mutual Funds for ETFs?

Post by alex_686 »

DB2 wrote: Thu Jun 17, 2021 6:51 pm How are MFs more risky here?
You put in your order.

It is filled at NAV.

NAV is a accountant’s estimate. These estimates are normally of a high quality but sometimes they fail miserably. I have personal insider experience from 2008. Probably happened again last spring.
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Re: Swap Mutual Funds for ETFs?

Post by anon_investor »

alex_686 wrote: Thu Jun 17, 2021 7:30 pm
DB2 wrote: Thu Jun 17, 2021 6:51 pm How are MFs more risky here?
You put in your order.

It is filled at NAV.

NAV is a accountant’s estimate. These estimates are normally of a high quality but sometimes they fail miserably. I have personal insider experience from 2008. Probably happened again last spring.
Do what do you use? ETFs or mutual funds?
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Re: Swap Mutual Funds for ETFs?

Post by alex_686 »

anon_investor wrote: Thu Jun 17, 2021 7:31 pm Do what do you use? ETFs or mutual funds?
A mixture. It depends. But I skew heavily towards ETFs.
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Re: Swap Mutual Funds for ETFs?

Post by AnEngineer »

DB2 wrote: Thu Jun 17, 2021 6:51 pm
AnEngineer wrote: Wed Jun 16, 2021 6:44 pm
DB2 wrote: Tue Jun 15, 2021 5:58 pm My biggest fear with ETFs is...making that sell and getting flash crashed (thinking what happened to Apple stock in 2012) or something extremely odd and rare happening not in my favor.
This is completely avoided by using limit orders with ETFs, whereas you cannot avoid the risk of this with MFs.
How are MFs more risky here?
You neither know nor can control the purchase or sale price. You can mitigate this somewhat by watching the market and putting an order in right before closing (4pm eastern). Practically, this I wouldn't worry too much about a flash crash with MFs, but it makes trying to tax loss harvest kind of risky.
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mdavis6890
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Re: Swap Mutual Funds for ETFs?

Post by mdavis6890 »

Thanks so much everybody for all the info! Sorry for the tardy follow-up as well. My plan is just to leave it alone. If I buy more, I'll buy ETFs.

There is one assumption that was driving this that sounds like it might not be true though:
ruud wrote: Tue Jun 15, 2021 10:15 am
mdavis6890 wrote: Tue Jun 15, 2021 8:50 am don't have to worry about paying taxes on dividends.
You'll have to pay taxes on dividends, whether they are from a mutual fund or an ETF. And for index funds/ETFs that track the same index, the dividends should be nearly the same regardless of whether it's a mutual fund or an ETF. Even more so, Vanguard mutual funds that have an ETF share class have the exact same tax efficiency as the ETF.
I thought the point was that EFT generally DON'T pay dividends to the investor. When the underlying stocks pay dividends, the fund would just re-invest those and the ETF price would go up. Is that false? Do ETFs pay dividends to the investor?
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Re: Swap Mutual Funds for ETFs?

Post by AnEngineer »

mdavis6890 wrote: Fri Jul 16, 2021 3:02 pm Thanks so much everybody for all the info! Sorry for the tardy follow-up as well. My plan is just to leave it alone. If I buy more, I'll buy ETFs.

There is one assumption that was driving this that sounds like it might not be true though:
ruud wrote: Tue Jun 15, 2021 10:15 am
mdavis6890 wrote: Tue Jun 15, 2021 8:50 am don't have to worry about paying taxes on dividends.
You'll have to pay taxes on dividends, whether they are from a mutual fund or an ETF. And for index funds/ETFs that track the same index, the dividends should be nearly the same regardless of whether it's a mutual fund or an ETF. Even more so, Vanguard mutual funds that have an ETF share class have the exact same tax efficiency as the ETF.
I thought the point was that EFT generally DON'T pay dividends to the investor. When the underlying stocks pay dividends, the fund would just re-invest those and the ETF price would go up. Is that false? Do ETFs pay dividends to the investor?
Yes, ETFs pay dividends.
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Re: Swap Mutual Funds for ETFs?

Post by alex_686 »

mdavis6890 wrote: Fri Jul 16, 2021 3:02 pm I thought the point was that EFT generally DON'T pay dividends to the investor.
Funds have to distribute all income earned at the end of the year as dividends. This is true for mutual funds and ETFs.

They generally don't pay capital gains, either long term or short term. Generally speaking, ETFs "trade" with their Authorized Participants (APs) by exchanging a underlying basket of securities for shares of the ETF. Since this is technically a exchange. as such, no income from capital gains, thus it does not trigger taxes. Generally speaking.

There is no similar dodge with normal dividends.
mdavis6890 wrote: Fri Jul 16, 2021 3:02 pm When the underlying stocks pay dividends, the fund would just re-invest those and the ETF price would go up. Is that false? Do ETFs pay dividends to the investor?
This is true, for both mutual funds and ETFs.

It helps if you focus on the point that the sole purpose of mutual fund dividends is to create "reportable transactions" so you can file taxes. That really is the only purpose. There is no economic benefit or change in total returns. For context, this used to be my day job.
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Re: Swap Mutual Funds for ETFs?

Post by iceport »

alex_686 wrote: Fri Jul 16, 2021 3:11 pm
mdavis6890 wrote: Fri Jul 16, 2021 3:02 pm I thought the point was that EFT generally DON'T pay dividends to the investor. When the underlying stocks pay dividends, the fund would just re-invest those and the ETF price would go up. Is that false? Do ETFs pay dividends to the investor?
They generally don't pay capital gains, either long term or short term.
And just so the OP is clear on this: Exactly the same thing can be said of good, traditional index mutual funds tracking "total market" indexes.

They generally don't pay out any capital gains distributions, either.
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Re: Swap Mutual Funds for ETFs?

Post by HootingSloth »

iceport wrote: Fri Jul 16, 2021 3:20 pm
alex_686 wrote: Fri Jul 16, 2021 3:11 pm
mdavis6890 wrote: Fri Jul 16, 2021 3:02 pm I thought the point was that EFT generally DON'T pay dividends to the investor. When the underlying stocks pay dividends, the fund would just re-invest those and the ETF price would go up. Is that false? Do ETFs pay dividends to the investor?
They generally don't pay capital gains, either long term or short term.
And just so the OP is clear on this: Exactly the same thing can be said of good, traditional index mutual funds tracking "total market" indexes.

They generally don't pay out any capital gains distributions, either.
Vanguard's total market index mutual funds, e.g. VTSAX, have not paid out capital gains distributions since an ETF share class was added to the same funds. Other total market index mutual funds, such as Fidelity's FSKAX or Schwab's SWTSX--which do not have an ETF share class--generally pay out small capital gains distributions in most years, just as Vanguard's funds used to do before an ETF share class was added.
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Re: Swap Mutual Funds for ETFs?

Post by alex_686 »

iceport wrote: Fri Jul 16, 2021 3:20 pm
alex_686 wrote: Fri Jul 16, 2021 3:11 pm
mdavis6890 wrote: Fri Jul 16, 2021 3:02 pm I thought the point was that EFT generally DON'T pay dividends to the investor. When the underlying stocks pay dividends, the fund would just re-invest those and the ETF price would go up. Is that false? Do ETFs pay dividends to the investor?
They generally don't pay capital gains, either long term or short term.
And just so the OP is clear on this: Exactly the same thing can be said of good, traditional index mutual funds tracking "total market" indexes.
This is false, or at the least misleading. I worked at a S&P 500 that paid out high capital gains.

Index funds tend to have lower turnover so their capital gains are lower. Tend. There are lots of exceptions out there.

Funds that are growing due to positive cash flow tend to have lower capital gains. They, generally speaking, don't have to sell their low cost basis stocks. Since they are not selling these they don't have capital gains distributions. Index funds have seen large inflows of cash. It is the cash inflow, not the index part, that is lowering their capital gains. That was the case for the fund that I was working at. Large outflows.

ETFs just have a bigger tool kit to avoid paying capital gains. They will always be more efficient than a comparable mutual fund.
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Re: Swap Mutual Funds for ETFs?

Post by iceport »

alex_686 wrote: Fri Jul 16, 2021 3:36 pm
iceport wrote: Fri Jul 16, 2021 3:20 pm
alex_686 wrote: Fri Jul 16, 2021 3:11 pm
mdavis6890 wrote: Fri Jul 16, 2021 3:02 pm I thought the point was that EFT generally DON'T pay dividends to the investor. When the underlying stocks pay dividends, the fund would just re-invest those and the ETF price would go up. Is that false? Do ETFs pay dividends to the investor?
They generally don't pay capital gains, either long term or short term.
And just so the OP is clear on this: Exactly the same thing can be said of good, traditional index mutual funds tracking "total market" indexes.
This is false, or at the least misleading. I worked at a S&P 500 that paid out high capital gains.

Index funds tend to have lower turnover so their capital gains are lower. Tend. There are lots of exceptions out there.

Funds that are growing due to positive cash flow tend to have lower capital gains. They, generally speaking, don't have to sell their low cost basis stocks. Since they are not selling these they don't have capital gains distributions. Index funds have seen large inflows of cash. It is the cash inflow, not the index part, that is lowering their capital gains. That was the case for the fund that I was working at. Large outflows.

ETFs just have a bigger tool kit to avoid paying capital gains. They will always be more efficient than a comparable mutual fund.
I'm sure your statements are technically correct. And my perspective is probably shaded by an element of "recency bias" in that pretty much all the index funds I use have been growing their asset bases significantly for many years now — which as you note makes it far easier to avoid capital gains distributions.

However, my assertion was qualified: I was speaking about good index funds. If an index fund experienced large outflows in this time period in which passive investing has gone from fringe to mainstream, one can only assume it had an unreasonably high expense ratio, or it didn't do a very good job of tracking its index.

In the context of the OP's question — which is where I based my response — I think it would be misleading to imply that it wouldn't be a cinch to find a good total market traditional index fund that doesn't distribute capital gains, or only distributes minimal gains on occasion.

Citing the practices of lousy traditional index mutual funds is not a valid reason to avoid a good traditional index mutual fund. It still seems to me as if the OP would simply like to own ETFs, and is in search of a justification. I don't believe tax-efficiency is a very good reason, given the abundance of excellent traditional index mutual funds out there.
HootingSloth wrote: Fri Jul 16, 2021 3:29 pm Vanguard's total market index mutual funds, e.g. VTSAX, have not paid out capital gains distributions since an ETF share class was added to the same funds. Other total market index mutual funds, such as Fidelity's FSKAX or Schwab's SWTSX--which do not have an ETF share class--generally pay out small capital gains distributions in most years, just as Vanguard's funds used to do before an ETF share class was added.
Yes, that's probably one factor. Another is the one alex_686 points out, that just about all Vanguard index funds have seem massive inflows for many years now.
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Re: Swap Mutual Funds for ETFs?

Post by HootingSloth »

iceport wrote: Sat Jul 17, 2021 5:30 pm
HootingSloth wrote: Fri Jul 16, 2021 3:29 pm Vanguard's total market index mutual funds, e.g. VTSAX, have not paid out capital gains distributions since an ETF share class was added to the same funds. Other total market index mutual funds, such as Fidelity's FSKAX or Schwab's SWTSX--which do not have an ETF share class--generally pay out small capital gains distributions in most years, just as Vanguard's funds used to do before an ETF share class was added.
Yes, that's probably one factor. Another is the one alex_686 points out, that just about all Vanguard index funds have seem massive inflows for many years now.
It is a very important factor for the reasons described earlier in this thread. Vanguard Total Stock Market Index Fund (VTSAX/VTSMX) had a capital gains distribution in each year from 1994 to 2000. It generally had massive inflows in those years as well. However, it has not had a capital gains distribution in any year since 2001. The ETF share class (VTI) was added on 05/24/2001.
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Re: Swap Mutual Funds for ETFs?

Post by iceport »

HootingSloth wrote: Sat Jul 17, 2021 6:06 pm
iceport wrote: Sat Jul 17, 2021 5:30 pm
HootingSloth wrote: Fri Jul 16, 2021 3:29 pm Vanguard's total market index mutual funds, e.g. VTSAX, have not paid out capital gains distributions since an ETF share class was added to the same funds. Other total market index mutual funds, such as Fidelity's FSKAX or Schwab's SWTSX--which do not have an ETF share class--generally pay out small capital gains distributions in most years, just as Vanguard's funds used to do before an ETF share class was added.
Yes, that's probably one factor. Another is the one alex_686 points out, that just about all Vanguard index funds have seem massive inflows for many years now.
It is a very important factor for the reasons described earlier in this thread. Vanguard Total Stock Market Index Fund (VTSAX/VTSMX) had a capital gains distribution in each year from 1994 to 2000. It generally had massive inflows in those years as well. However, it has not had a capital gains distribution in any year since 2001. The ETF share class (VTI) was added on 05/24/2001.
Okay, but take a quick look at the distributions for Vanguard's S&P 500 index fund: Vanguard 500 Index Fund tax distributions

That fund did not add an ETF share class until 2010, yet had a very similar distribution history, i.e. no CG distributions for the 10 years from 2000 through 2009.

But it's worth noting the amount of CG distributions. Even when there were CG distributions, they were fairly negligible.
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Re: Swap Mutual Funds for ETFs?

Post by HootingSloth »

iceport wrote: Sat Jul 17, 2021 6:19 pm
HootingSloth wrote: Sat Jul 17, 2021 6:06 pm
iceport wrote: Sat Jul 17, 2021 5:30 pm
HootingSloth wrote: Fri Jul 16, 2021 3:29 pm Vanguard's total market index mutual funds, e.g. VTSAX, have not paid out capital gains distributions since an ETF share class was added to the same funds. Other total market index mutual funds, such as Fidelity's FSKAX or Schwab's SWTSX--which do not have an ETF share class--generally pay out small capital gains distributions in most years, just as Vanguard's funds used to do before an ETF share class was added.
Yes, that's probably one factor. Another is the one alex_686 points out, that just about all Vanguard index funds have seem massive inflows for many years now.
It is a very important factor for the reasons described earlier in this thread. Vanguard Total Stock Market Index Fund (VTSAX/VTSMX) had a capital gains distribution in each year from 1994 to 2000. It generally had massive inflows in those years as well. However, it has not had a capital gains distribution in any year since 2001. The ETF share class (VTI) was added on 05/24/2001.
Okay, but take a quick look at the distributions for Vanguard's S&P 500 index fund: Vanguard 500 Index Fund tax distributions

That fund did not add an ETF share class until 2010, yet had a very similar distribution history, i.e. no CG distributions for the 10 years from 2000 through 2009.

But it's worth noting the amount of CG distributions. Even when there were CG distributions, they were fairly negligible.
I agree the mutual fund capital gains distributions for broad based passive index funds without an ETF share class are typically quite small each year. I think the incremental tax drag is typically significantly larger, though, than the differences in expense ratios for these kinds of funds that many seem to care about.
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