Nithin Kamath, founder and chief executive officer of Zerodha, took to social media to share his recent learnings about ETFs in the US and why they are preferred over mutual funds in the country.
"Something I learned recently on why ETFs in the US are preferred over MFs," he said on X as he began to explain.
He went on to explain that in the US, mutual funds are pass-through vehicles. This means that if they generate capital gains, these must be distributed to unit holders who pay the taxes on the gains. This makes MFs less tax-efficient.
"ETFs avoid this through 'in-kind' creation/redemption that washes away gains. This tax advantage is significant. This is one underrated reason for the popularity of index funds, especially ETFs in the US," Kamath wrote on X.
"In India, both MFs and ETFs don't pass taxes to unit holders...," he added.
Something I learned recently on why ETFs in the US are preferred over MFs. 😬
February 20, 2025
US mutual funds are pass-through vehicles—if they generate capital gains, these must be distributed to unit holders who pay the taxes on the gains which makes MFs less tax-efficient. ETFs avoid this… pic.twitter.com/T6sks6qU1GThree Advantages
Taking the conversation further, the founder and chief executive officer of Capital Mind, Deepak Shenoy, pitched in a lot more perspective to the thread.
"Indeed and in fact the tax advantage is why ETFs shine in the US. Redeeming ETF units in exchange for the underlying shares, what market makers generally do, is not taxable for the ETF, it's like a buy back of sorts," he said.
Mutual funds in the US though, when sold, record capital gains for all unitholders. Investors are then sent a tax note stating that taxation applies for US citizen unit holders.
Shenoy goes on to list three ETF advantages that remain in India:
The first one is the fact that ETFs can be used for intraday buying during a steep fall. Investors need to note that this does not work on days like election results day, when the markets were down 6% last time.
Secondly, ETFs can have any investor owning more than 25% of all units, which is a restriction in a mutual fund.
"That is an advantage for say EPFO owning nearly all of the SBI Nifty ETF for example. Normal people don't care about this, of course," he said.
For the final advantage, Shenoy said that ETFs don't pay securities transaction tax when buying or selling stocks.
He, however, said, "There isn't that much of an advantage in India for ETFs over index funds, though the STT advantage is meaningful over a holding period of a decade."
Indeed and in fact the tax advantage is why etfs shine in the US. Redeeming ETF units in exchange for the underlying shares, what market makers generally do, is not taxable for the ETF, it's like a buy back of sorts. Mutual funds though, when they sell shares record capital… https://t.co/L8uQs7xVyQ
February 21, 2025ETFs In India Vs US
ETFs are a pain for some investors, according to Shenoy.
"Etfs are a pain for investors who need to keep checking inav (a something on a fund web page that tells you the real underlying nav) versus the market price, and in many cases you can be paying significantly higher prices. Worse, if you place overnight orders for etfs, you're very likely to get a horrible price. I've even seen 5% higher than inav," wrote Shenoy.
Bringing it back to the primary comparison in the thread, Shenoy said that ETFs in the US can be active, without tracking an underlying index, so can be issued even by active funds.
While in India they can only be passive, which means that they need to follow an index. He concluded by saying that ETFs make sense in the US for small investors, not in India. But, they still provide a different way to invest into an index.
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