Why is an ETF that generates less capital gain distributions better for some investors?

Question

Question
From an investor prospective, why an ETF that generates less capital gain distributions to the investors is better than one that generates more distributions? Note, I am not talking about "capital gain", but "capital gain distributions". Thank you.

Example
I have one share of an ETF.
The ETF price and the NAV are 100.
The ETF realizes capital gain and distributes 2 to me.
I pay 0.5 taxes on it, so the after tax distribution is 1.5.
After the distribution the new NAV is 100-2 = 98. The ETF price is still temporarily at 100.
The Authorized Partecipants use arbitrage to bring the ETF price and NAV to a new value somewhere between 98 and 100, say that the new value is 99.
From the investor prospective:

• Before the distribution I had 100
• After the distribution I have 99 + 1.5 = 100.5

So, in this example, the capital gain distribution was a good thing for the investor. I understand that, for example, if the new equilibrium was at a different price (say 98.1) you may have that the investor lost money with the distribution.

Conclusion
I think that sometimes the distribution is a good thing, sometimes it is not.

Answer 1

Your assumption that the value of the ETF will be "somewhere between 98 and 99" is too imprecise. It's not "arbitrage" that draws the price down; the actual price makes a discontinuous jump at the time of the dividend since the exchange modifies limit orders (which determine the bid/ask range) to account for the dividend. After the distribution of 2 and taxes of 0.5, the "value" (the amount you would get if you sold) of the ETF would be 98, and you'd have

98 + 1.5 = 99.5

where the 0.5 loss is all attributable to taxes. If you did not account for taxes and reinvested the distribution, you'd have 100 total either way (either 100 of the ETF or 98 of the ETF and 2 in cash)

So the main drawback of distributing ETFs is the immediate tax impact. As mentioned in other answers, this is of no consequence in tax-deferred retirement accounts, and if you reinvest the distribution you'd end up with 100 of the ETF whether it paid a dividend or not.

Answer 2

Why an ETF that generates less capital gain distributions to the investors is better than one that generates more distributions?

This answer will use United States terms:

• If a person has the money in a Roth account, the distributions have no tax impact.
• If a person has the money in a traditional 401(k) or traditional IRA, the tax impact of the distribution is deferred.
• if the person has the money in a taxable account, then there is a tax impact this year instead of when they sell.

Each group of people will view capital gains distributions differently. Even the people in the taxable account group will view the distributions differently depending on if they want the distributions as income this year.

from a comment:

Can you elaborate on "Even the people in the taxable account group will view the distributions differently depending on if they want the distributions as income this year."? I thought that an ETF capital gain distribution is always taxes (usually as long term capital gain)

If a person is decades from retirement then a distribution triggers a tax with no immediate benefit. But if they are retired, then those distributions may be part of their income plan. They might not be reinvesting distributions, so they will keep the same number of shares and spend the distribution.