Q4 2021 Tax-Loss Harvesting: Fixed Income and China ETFs

By: Matthew J Bartolini, CFA & Martin D Dunn

  • Tax-loss harvesting is the act of selling a security in a taxable account at a loss and using the loss to offset realized taxable gains to help reduce taxes.
  • The rise in interest rates has put downward pressure on bond prices across many sectors, creating tax-loss harvesting opportunities for fixed income positions in a year when most equity exposures — with the exception of China-region equities — have rallied.
  • After harvesting losses, consider low-cost ETFs whether you are investing sale proceeds in a swap or more permanent portfolio replacement.

Interest rates rose sharply at the end of September as the US 10-year Treasury yield spiked 31 basis points from 1.30% to 1.61% today.1 As a result, investors likely felt a twinge of pain from their fixed income holdings.

While the increase in rates has put downward pressure on bond prices across many sectors, all is not lost.

The silver lining? This weakness has created tax-loss harvesting opportunities for fixed income positions in a year when most equity exposures have rallied — except for Chinese equities.2

Our Process to Find Tax-Loss Harvesting Opportunities

Tax-loss harvesting is the act of selling a security in a taxable account at a loss and using the loss to offset realized taxable gains to help reduce taxes.

Before analyzing where the opportunities for tax-loss harvesting reside, it is important to distinguish between a security’s total return and price return. Total return considers all income received from a security throughout the investor’s holding period (dividends, interest, etc.). In the case of tax-loss harvesting, price return is what matters. An investor’s capital gains liability (or loss) is based on the purchase price and the sale price, without any regard for dividend or interest payments received.

For this study, we calculated the year-to-date price change for every US-listed exchange traded fund (ETF) through October 11th (approx. 2,800 funds). We then set a price loss threshold of 2% to flag funds that could potentially be tax-loss harvesting candidates. Once we identified all the funds that met this threshold, we segmented them based on their Morningstar categories and aggregated the data in order to identify trends.

Most Tax-Loss Harvesting Opportunities Are in Bonds

Because the income received is such a large component of a bond’s return, this asset class often can be overlooked when tax-loss harvesting. Investors often view a bond exposure as having generated positive total return due to the income received, when the price return has a loss.

The sharp rise in rates has pushed approximately four out of every five fixed income ETFs into year-to-date price losses. And approximately one in every three funds currently has a price loss of more than 2%3 (see Figure 1). For bond investors, this presents a plethora of positions that could be harvested this autumn.

Figure 1: Percent of Fixed Income ETFs in Price Losses YTD

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Footnotes

1Bloomberg Finance L.P. as of October 8, 2021.
2Bloomberg Finance L.P. as of October 8, 2021. The year-to-date price change of the S&P 500, MSCI EAFE, and MSCI ACWI is 16.11%, 10.72% and 5.94%, respectively. The year-to-date price change of the MSCI China is -14.70%. Past performance is not an indicator of future performance.
3Morningstar, Bloomberg Finance L.P., as of 10/11/2021. Calculations by SPDR Americas

Glossary

S&P 500 Index A market-capitalization-weighted index of 500 leading publicly traded companies in the U.S. It is not an exact list of the top 500 U.S. companies by market cap because there are other criteria to be included in the index.

MSCI ACWI Index A stock index designed to track broad global equity-market performance, All Country World Index (ACWI). Maintained by Morgan Stanley Capital International (MSCI), the index is comprised of the stocks of about 3,000 companies from 23 developed countries and 26 emerging markets.

MSCI AEFE Index Designed to represent the performance of large and mid-cap securities across 21 developed markets, including countries in Europe, Australasia and the Far East, excluding the U.S. and Canada. Europe, Australasia (the region made up of Australia and New Zealand), and the Far East.

Originally Posted on October 25, 2021 – Q4 2021 Tax-Loss Harvesting: Fixed Income and China ETFs

Disclosures

Important Risk Information
The views expressed in this material are the views of Matthew Bartolini and Martin Dunn through the period ended October 20, 2021 and are subject to change based on market and other conditions. This document contains certain statements that may be deemed forward-looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected.

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Investing involves risk included the risk of loss of principal.

Diversification does not ensure a profit or guarantee against loss. 

Equity securities may fluctuate in value in response to the activities of individual companies and general market and economic conditions.

Non-diversified funds that focus on a relatively small number of securities tend to be more volatile than diversified funds and the market as a whole.

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Bonds generally present less short-term risk and volatility than stocks, but contain interest rate risk (as interest rates rise, bond prices usually fall); issuer default risk; issuer credit risk; liquidity risk; and inflation risk. These effects are usually pronounced for longer-term securities. Any fixed income security sold or redeemed prior to maturity may be subject to a substantial gain or loss.

Investments in mortgage securities are subject to prepayment risk, which can limit the potential for gain during a declining interest rate environment and increase the potential for loss in a rising interest rate environment. The mortgage industry can also be significantly affected by regulatory changes, interest rate movements, home mortgage demand, refinancing activity, and residential delinquency trends.

Investing in high yield fixed income securities, otherwise known as “junk bonds”, is considered speculative and involves greater risk of loss of principal and interest than investing in investment grade fixed income securities. These Lower-quality debt securities involve greater risk of default or price changes due to potential changes in the credit quality of the issuer.

The funds presented herein have different investment objectives, costs and expenses. Each fund is managed by a different investment firm, and the performance of each fund will necessarily depend on the ability of their respective managers to select portfolio investments. These differences, among others, may result in significant disparity in the funds’ portfolio assets and performance. For further information on the funds, please review their respective prospectuses.

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Bonds generally present less short-term risk and volatility than stocks, but contain interest rate risk (as interest rates raise, bond prices usually fall); issuer default risk; issuer credit risk; liquidity risk; and inflation risk. These effects are usually pronounced for longer-term securities. Any fixed income security sold or redeemed prior to maturity may be subject to a substantial gain or loss.

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Investing in high yield fixed income securities, otherwise known as “junk bonds”, is considered speculative and involves greater risk of loss of principal and interest than investing in investment grade fixed income securities. These Lower-quality debt securities involve greater risk of default or price changes due to potential changes in the credit quality of the issuer.

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Definition:

Arbitrage: the simultaneous buying and selling of securities, currency, or commodities in different markets or in derivative forms in order to take advantage of differing prices for the same asset.

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