Tax-Loss Harvesting: A Silver Lining for Single-Country ETFs?

While the subject of taxes would probably elicit a yawn as dinner party conversation (assuming dinner parties happen again at some point), it’s something many investors need to contemplate as year-end approaches. David Mann, our Head of ETF Capital Markets, discusses the concept of tax-loss harvesting and how it can be a silver lining for investors in single-country exchange-traded funds (ETFs).

Federal and state laws and regulations are complex and subject to change, which can materially impact your results. Always consult your own independent financial professional, attorney or tax advisor for advice regarding your specific goals and individual situation.

I have always thought of the tax-loss harvesting year-end discussion as an annual tradition on par with Thanksgiving dinner. However, given that I actually only wrote about this concept in 2016 and 2018, maybe biannual is a bit more accurate! Feel free to click on the links above for a refresh of either the definition of tax-loss harvesting or why it is deployed as a year-end strategy. As a quick refresher, tax-loss harvesting refers to a strategy whereby poorly performing investments are sold at a loss, and those losses are used to offset realized taxable gains on other investments.

For today, I wanted to revisit our 2018 discussion on tax-loss harvesting within the single-country ETF space, given the wide divergence among global markets during the madness that we call 2020. As a reminder from that blog:

Tax-loss harvesting is the silver lining for owners of single-country ETFs that are down for the year. And for some of these countries, we think things seem to be lining up this year:

• A particular country being down for the year presents the opportunity to tax-loss harvest.
• There are now low-cost, single-country ETFs that provide access to those markets at a fraction of their largest competitors’ cost, allowing investors to maintain their exposure.
• There are ETF liquidity providers who can leverage the trading of the underlying basket to minimize the transition costs.

One of the key considerations when making a tax-loss harvesting decision is whether a similar or highly correlated ETF exists that will allow the investor to maintain their desired exposure. As we mentioned in our post two years ago, Franklin Templeton offers a suite of single country funds (19 in total) that provide access to those markets at a fraction of the cost—40 basis points lower on average.¹

Two years later, we can see how those 19 single-country ETFs have performed as compared to the largest ETF in the market providing exposure to that same country. On average our funds have outperformed the largest by 1% (NAV Returns) and 0.42% (Market Price Returns)² for the two-year period ending 10/12/20!³ See performance table here.

There are once again plenty of opportunities for tax-loss harvesting within the single-country ETF space. Sticking with those 19 global markets and looking at their daily performance over the past two years, we estimate that around half of all purchases made during that period would now be at a loss. For several of those markets, we estimate that number is closer to 80%.⁴

With so many opportunities, the timing for investors seeking to harvest a tax loss may be favorable. Furthermore, ETF market makers have become even more comfortable in providing transition trades with almost no market impact when measured in terms of the fund’s bid/ask spread. To be honest, talking about any strategy built on the foundation of losses in a portfolio kind of stinks. However, hopefully we can all agree that when it comes to losses (and tax liabilities), the smaller, the better.