Several Exchange Traded Funds (ETFs) across the Australian Stock Exchange (ASX) experienced sharp share price declines around the same time last week.
The Betashares Nasdaq 100 ETF (ASX: NDQ) declined 3.27% or $1.05 on July 1.
ETF Securities FANG ETF (ASX: FANG) fell 9.46% or $1.76 on June 30.
BetaShares Global Sustainability Leaders ETF (ASX: ETHI) recorded a 5.32% or $0.68 fall on July 1.
ETF Securities Battery Tech & Lithium ETF (ASX: ACDC) decreased 5.44% or $5.19 on June 30.
The underlying companies or investments weren’t impacted nearly as much. Some were even up on the day. So what caused the sudden drop?
Ex-distribution
At certain dates throughout the year (often quarterly or semi-annually), the ETF will distribute proceeds collected from asset sales, company dividends and other proceeds to ETF unit holders.
As a result of the distributions and all else remaining equal, the value of the ETF unit falls, usually in line with the distribution amount at the time. This is known as ‘ex-distribution’.
If you hold the ETF before the ex-distribution date, then it is known as ‘cum-distribution’ and you will receive the distribution proceeds.
If you hold the ETF after the ex-distribution date, then you will not receive the proceeds and will have to wait until the next ex-distribution date.
Many ETFs have ex-distribution dates around or on 30 June or July 1 to coincide with the start of a new financial year.
100 = 10 + 90
It can be difficult to conceptualise so let’s use an example.
An ETF has $100 million in assets and is set to distribute $10 million of the assets as a distribution to unitholders.
Post the ex-dividend date, unitholders will hold units in the ETF, which now has $90 million in assets. Since the number of units remains the same but the assets have decreased 10% the unit price falls 10%.
Additionally, the unitholders will now hold the $10 million distribution in their own names (bank accounts).
The amount of money remains the same. However, instead of 100% held by the ETF, 10% is held in your name and 90% by the ETF.
Why does an ETF make distributions?
ETFs operate under a trust legal structure, whereby the units each investor owns represents a slice of the trust’s total assets (often shares, property or bonds).
Because you hold units in the trust, you are a beneficiary. Trusts are not able to pay tax on your behalf, so the proceeds from the ETF is passed onto you (the beneficiary) corresponding to your number of units.
Whenever a share is sold, the capital gain or loss is recorded in your name. Similarly when a dividend is paid this is passed on to you. Other proceeds include foreign exchange, hedging and gains on rebalancing.
The collective sum of these proceeds is known as distributions.
The ETF issuer is unable to reinvest distributions directly on your behalf. You have to either opt into a distribution reinvestment plan (DRP) or purchase new units on the market. In either case, your new units via the DRP or open market will have a new cost base.
Alternatively, you may opt to keep the distributions as a form of income. However, you will not benefit from compounding.
Final comments
ETF distributions is not an easy concept to get your head around, so don’t stress if it takes time to understand it.
I personally subscribe to DRPs to avoid having to think about distributions. It automatically invests the proceeds into more units and I benefit from compounding.
If you’re looking for further information about distributions, check out this helpful explainer by BetaShares.
Alternatively, if you’re interested in learning more about ETFs, I highly recommend Rask’s Beginner ETF Investing Course.
It’s completely free and only takes one hour to complete.
