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Rich Americans Cut Tax Bills With Money-Losing Bonds

“Fixed-income is really the only game in town if you want to harvest losses at this point in the year.”

(Bloomberg) -- Rich Americans nursing big bond losses in the year inflation roared back are discovering there’s a silver lining to the pain in their portfolios: It’s cutting their tax bill.

The bull market across U.S. stocks in 2021 has been so widespread that there aren’t many losers to deploy in tax-loss harvesting -- the practice of selling money-losing securities to offset against a capital gains tax bill. So advisers and their clients are turning to bonds instead.

“Fixed-income is really the only game in town if you want to harvest losses at this point in the year,” said Matt Bartolini, head of SPDR Americas Research at State Street, which cut fees for three credit products ready for tax season. “In equities, it’s hard to find anything that’s not up.”  

The S&P 500 has soared 25% this year, with gains in every sector as more than 400 members climb. The result is less than 15% of U.S. equity exchange-traded funds are underwater. 

For bond ETFs, it’s almost half. As economies reopen, inflation surges and central banks scale back stimulus, funds like the $19 billion iShares 20+ Year Treasury Bond ETF (ticker TLT) have suffered. TLT is on track for the biggest decline since 2013, according to data compiled by Bloomberg.

Fueled by price growth expectations and rate liftoff bets, rising Treasury yields have rippled across other debt markets. The $91 billion iShares Core U.S. Aggregate Bond ETF (AGG) -- which spans government debt to corporate bonds to mortgage-backed securities -- has dropped over 3% this year, its worst showing in eight years. 

“A strategy we’ve seen more investors and advisers employ is swapping out of one bond ETF into another,” said Ben Johnson, director of global ETF research at Morningstar Inc. “ETF providers, in particular, take time to market those types of tactics around this time of year.”

State Street lowered the expense ratios on three of its credit ETFs this month to just 0.04%. The timing of the fee cut was partly to boost the products’ appeal for tax-loss harvesting purposes, the head of fixed-income research at the firm’s SPDR group said. 

ETFs are already often favored among tax-conscious investors because the way they usually work -- using a market maker to do in-kind redemptions -- reduces the tax burden on the fund. 

That gives them an advantage over most mutual funds, in which a manager typically must sell securities in order to raise cash to meet investor redemptions. That’s a taxable transaction, the cost of which tends to fall on remaining holders. 

This year’s bill will likely be higher for mutual fund investors, according to Keefe Bruyette & Woods’s Melissa Roberts, given that equity products are on track for a seventh straight year of outflows amid a robust rally. 

“Within the mutual fund world, the capital gains are going to be higher this year because you’ve had this combination of persistent outflows and equity appreciation in the funds,” Roberts said. “Many of the funds are having to sell appreciated assets.” 

Of course, a 3% slump in a bond ETF isn’t going to entirely neutralize the bill for any investor paying tax on a double-digit stock gain, Bartolini said. But amid a sea of green, it can help blunt some of the blow. 

“These aren’t going to be gigantic losses, but in a world where everything has gone up, even a little bit of tax-loss harvesting can be helpful when you’re eyeing your overall tax bill,” Bartolini said. 

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