ProShares’ newfound tax efficiency is surprising and welcome. Will the other leveraged funds follow suit?

In case you missed it, ProShares announced today that it will pay zero capital gains on its complete family of ETFs in 2009. That’s shocking, given the huge cap-gains payouts by inverse ETFs in 2008. I would have thought, given the huge run in the market this year, that leveraged funds would have accumulated large distributions.

In fact, I had a half-written blog warning investors to sell out of leveraged ETFs ahead of the 2009 distribution announcements. I was worried that investors would get stuck with large distributions yet again, and didn’t want to see that happen. It was lucky timing that the ProShares announcement jumped ahead of me publishing that blog.

The question now is, will other leveraged and inverse ETF providers like Rydex and Direxion Shares follow suit?

On one level, I think the answer is yes. Given the zero gains at ProShares, it’s unlikely we’ll see the kinds of distributions we saw in 2008, when many funds paid upward of 30 percent (and in the case of one fund from Rydex, paid more than 80 percent) of their net asset values in capital gains.

But I wouldn’t look for zero capital gains across the whole universe. The largest gains in 2008 were concentrated in smaller funds, and if I were a tax-sensitive investor, I’d be worried about funds with small assets under management going into the 2009 distribution season.

There are lots of things that ETF providers can do to manage tax distributions, including using the creation/redemption facility to effectively distribute gains to institutional investors during the course of the year. But smaller funds that have less creation/redemption activity are limited in their ability to do this.

My guess is that we’ll still see some capital gains distributions in the leveraged space in 2009, but they will be nothing like what we saw in 2008, and will be focused on the smaller, less-loved funds.

Leveraged and inverse ETFs are most appropriate for traders who may not care about capital gains distributions. But investors in leveraged ETFs outside of the ProShares family may still want to be on their toes as we move into distribution season.