ETF Capital Markets Desk: A Taxing Time of Year Need Not Be

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    David MannHead of Capital Markets, Global Exchange-Traded Funds (ETFs), Franklin Templeton Investments

    The end of the year is often a time to make plans and resolutions—and for many investors, a time to do some strategic planning. David Mann, our head of Capital Markets, Global ETFs, discusses one year-end strategy: tax-loss harvesting. He sees it as an opportune time to examine one’s portfolio and consider if any shifts are in order.

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    Tax-Loss Harvesting

    With the end of each year comes the joyous holiday season, as well as the longstanding tradition of tax-loss harvesting in ETFs. Quick side note: can writing a blog about a tradition become a tradition?  The mind does wander sometimes.

    Anyway, as mentioned in my prior blog post on this topic: “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.”

    This process opens the opportunity to transition into a different fund without worrying about the potential impact of realizing capital gains. With tax implications either out of the way or a net benefit, the transition decision is now no different than making any other investment decision in terms of where to deploy cash.

    The drivers of the decision to invest in a particular fund over another can include different risk-adjusted returns, portfolio philosophy, specific desired market exposure, fees, etc.

    We have talked about the different types of ETFs in these pages for some time (passive, smart beta and active) but usually from a structural perspective—check out the ETF Rule proposal for the Securities and Exchange Commission’s (SEC’s) view on the differences between actively managed and index-based ETFs.

    However, from an investment perspective, I put ETFs into two main buckets:

    1. For the active/smart beta ETF, the investor wants a specific outcome and thus wants a detailed understanding of the construction of the portfolio.
    2. For index-based or passive ETFs, the investor wants access to a specific market as inexpensively as possible.

    Combining the idea of inexpensive access to a specific market with the benefit of tax-loss harvesting has been challenging considering the long bull run in the US equity markets. The same cannot be said when looking at other global markets where there has been a fair amount of turbulence.

    For example, Brazil’s equity benchmark index began the year with double-digit gains, switched to losses of more than 20%, and then recovered to around +16% year to date currently.1

    Certainly, while there are some countries with equity markets in the green this year, there are also others with losses.

    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 the 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.

    Investing in an ETF that drops in price is never fun, but hopefully those who are faced with that situation can consider it an opportunity to switch to a lower-cost version that gives a similar exposure.

    This information is intended for US residents only.

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    1. As of November 5, 2018. Based on the Ibovespa Brasil Sao Paulo Stock Exchange Index. Indexes are unmanaged and one cannot directly invest in them. They do not include fees, expenses or sales charges. Past performance is not an indicator or guarantee of future performance.

    The comments, opinions and analyses are the personal views expressed in this blog are intended to be for informational purposes and general interest only and should not be construed as individual investment advice or a recommendation or solicitation to buy, sell or hold any security or to adopt any investment strategy. It does not constitute legal or tax advice. The information provided in this material is rendered as at publication date and may change without notice and it is not intended as a complete analysis of every material fact regarding any country, region, market or investment.

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