Recall earlier that we mentioned how ETF sponsors are more tax efficient and that their transactions are not taxed as much compared to traditional mutual funds. One reason is that ETF sponsors do not deal directly in cash. During ETF share creation, an ETF sponsor creates shares and receives a bundle of stocks of equal value. Similarly during the redemption process the sponsor gives a bundle of stocks in exchange for ETF shares of equal value. Since the two items being exchanged are of the same value there’s no capital gain that is recorded. This is important because capital gains are taxed by the government. We can contrast this with an open-end mutual fund. If an investor requests to withdraw their investment the mutual fund may need to sell some stocks for cash to give to the investor the capital gains taxes on the stock sales add to the operational costs of the fund and these costs are reflected in the higher fees that the mutual fund charges investors.