Exchange-traded funds (ETFs) are investment vehicles that hold baskets of securities and trade on stock exchanges throughout the day. They were launched in 1990 to allow investors to trade throughout the day, unlike mutual funds which settle once daily.
As of mid-2025, ETFs hold $15.5trn in assets under management. They now hold over 9% of all American companies' stocks, up from 0.2% in 2000. The less tax-efficient mutual-fund sector, by contrast, peaked in 2008 at 25% of stockmarket ownership and has since fallen to 17%.
ETFs are considerably more tax-efficient than mutual funds. When investors trade in and out, they do so on a secondary market with other investors, without triggering sales by the fund itself. When an ETF needs to trade on the primary market to accommodate large inflows or outflows, it typically exchanges a basket of appreciated stocks for ETF shares "in kind"; because no cash changes hands, the Internal Revenue Service does not treat this as a taxable event. The legal basis for this in-kind redemption mechanism dates to 1986.
Research by Derek Horstmeyer of George Mason University found an average "tax alpha" of 0.2 percentage points a year for ETFs over mutual funds — more than the total decline in average fees on passive funds over the past 30 years. Research by Rabih Moussawi at Villanova University found that different tax regimes account for most of the reallocation from mutual funds to ETFs, even controlling for fees and performance.
The first emerging-market ETFs linked the stockmarkets of more than 20 countries into a single fund, broadening access to global investing. Bond ETFs later did the same for fixed income, connecting dealer markets with public exchanges so investors could trade more efficiently. Spot bitcoin ETFs subsequently brought digital assets onto traditional exchanges.
The growth of ETFs has spurred adjacent tax-aware strategies. Separately managed accounts (SMAs), which hold securities directly and can be tailored to each investor, held $2.7trn in assets as of mid-2025. Combined SMA assets at BlackRock, Goldman Sachs, Morgan Stanley and JPMorgan were worth $1.4trn at the end of 2024 — roughly $400bn more than the assets managed by the world's 20 largest hedge funds. Direct indexing, which involves holding the individual stocks of an index to enable selective tax-loss harvesting, had $865bn invested, with S&P Global expecting it to reach $1.1trn by 2028.
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