Tax efficiency

Unlike traditional open-end mutual funds, purchases and redemptions by other shareholders have either less or no impact on ETF investors. The creation and redemption process allows some or all share activity to be facilitated through the in-kind distribution transfers with institutional investors, preventing or reducing the amount of capital gains incurred by the fund as a result of shareholder trades. However, the ETF structure does not necessarily eliminate all capital gain distributions.

Creation and redemption process Before discussing the process that makes an ETF more tax efficient, it is important to understand how traditional mutual funds operate. Mutual fund shareholders, either directly or through a broker, purchase and redeem shares from the fund in exchange for cash. When investors send cash to purchase shares, the fund manager can either hold the cash or purchase additional securities for the fund through the capital markets. Conversely, when investors redeem their shares, the fund manager will often have to sell securities in order to raise the cash needed to meet the redemption. This may generate a capital gain which gets passed along to the remaining shareholders of the fund. In a year where the fund experiences negative performance, investors can be particularly disappointed when they receive unwanted taxable capital gains distributions.
Unlike traditional mutual funds, only Authorized Participants (APs) can create or redeem ETF shares directly with the fund in very large blocks of shares called creation units. APs consist of market makers, large investors, specialists or institutional broker/dealers. To create units, the AP generally purchases a basket of securities, which represents the ETF�s holdings, through the capital markets and delivers them to the fund custodian. In return, the custodian delivers the appropriate number of ETF shares to the AP. This transaction is typically done in-kind, meaning that securities are exchanged for ETF shares. Once the AP receives the ETF shares, the shares are then sold to investors on the open market just like shares of stock. Although the ETF structure does not guarantee that there will never be capital gains distributions, it is this in-kind transfer mechanism that makes ETFs more tax efficient than their open-end fund counterparts.

Redemptions are simply the opposite of the creation process. Creation units are generally redeemed in exchange for the underlying securities through an in-kind transfer between an AP and the fund custodian.

You should consider a fund's investment objectives, risks, and charges and expenses carefully before investing. Contact your financial advisor or call First Trust Portfolios L.P. at 1-800-621-1675 to request a prospectus, which contains this and other information about a fund. Read it carefully before you invest.

Risk considerations
A fund's shares will change in value, and you could lose money by investing in a fund. An investment in a fund involves risks similar to those of investing in any fund of equity securities traded on exchanges. One of the principal risks of investing in a fund is market risk. Market risk is the risk that a particular stock owned by a fund, fund shares or stocks in general may fall in value.

You should anticipate that the value of the shares will decline, more or less, in correlation with any decline in the value of the index. A fund's return may not match the return of the index. A fund may not be fully invested at times. Securities held by a fund will generally not be bought or sold in response to market fluctuations and the securities may be issued by companies concentrated in a particular industry. A fund may invest in small capitalization and mid capitalization companies. Such companies may experience greater price volatility than larger, more established companies.

Investors buying or selling fund shares on the secondary market may incur brokerage commissions. Investors who sell fund shares may receive less than the share's net asset value. Unlike shares of open-end mutual funds, investors are generally not able to purchase ETF shares directly from the fund and individual ETF shares are not redeemable. However, specified large blocks of shares called "creation units" can be purchased from, or redeemed to, the fund.

The information contained in this document does not constitute tax advice. Please consult your tax advisor for specific information about your tax situation.