Why ETFs are more popular than mutual funds in the US: Zerodha's Nithin Kamath explains

Exchange-traded funds (ETFs) are gaining traction globally, especially in the US, where they dominate mutual funds. In January 2025, the US ETF industry recorded a net inflow of $90.3 billion, the highest ever.

So, what makes ETFs so attractive compared to mutual funds in the US?

Zerodha CEO Nithin Kamath believes taxation plays a key role.

In a post on X (formerly Twitter), Kamath explained why ETFs in the US have an edge over mutual funds. He pointed out that US mutual funds operate as pass-through vehicles, meaning they distribute capital gains to unit holders, who must then pay taxes on those gains.

This structure makes mutual funds less tax-efficient.

ETFs, on the other hand, use an ‘in-kind’ creation and redemption mechanism. This process helps ETF issuers manage gains more efficiently, preventing the distribution of taxable capital gains to investors.

As a result, ETFs enjoy a significant tax advantage, which Kamath considers an underrated reason for their popularity.

The Indian scenario: ETFs vs mutual funds

Kamath noted that in India, both mutual funds and ETFs do not pass taxes directly to unit holders. This is different from Portfolio Management Services (PMS) and Category 3 Alternative Investment Funds (AIFs), which do pass through taxes.

Despite this, ETFs in India have been witnessing increasing investor interest, especially in index-based investing.

Data shows a shift in investor preferences.

Investors appear to be moving towards cost-efficient, passive investment options.

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