In our last episode, we discussed the importance of a portfolio’s asset allocation, and, how that relates to “Reducing Your Tax Bill”. In part two of this episode, we are joined once again by Symmetry’s Managing Director of Research and Investments, Philip McDonald, CFA, CAAIA & Glenn Shirley, CAIA, Head of Investor Relations for Quantinno Capital Management, to discuss the methods by which you can “re-charge that tax benefit”.
You can also find us on Facebook, YouTube, Twitter, and LinkedIn. As always, we remain invested in your goals.
Symmetry Partners, LLC, is an investment advisory firm registered with the Securities and Exchange Commission. The firm only transacts business in states where it is properly registered, excluded or exempted from registration requirements. Registration of an investment adviser does not imply any specific level of skill or training and does not constitute an endorsement of the firm by the Commission. No one should assume that future performance of any specific investment, investment strategy, product or non-investment related content made reference to directly or indirectly in this material will be profitable. As with any investment strategy, there is the possibility of profitability as well as loss.
Due to various factors, including changing market conditions and/or applicable laws, the content may not be reflective of current opinions or positions.
Please note the material is provided for educational and background use only. Moreover, you should not assume that any discussion or information contained in this material serves as the receipt of, or as a substitute for, personalized investment advice.
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Hello listeners,
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welcome back to part two of our conversation on
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investing in taxes. Once again, I'm joined by Glenn
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Shirley from quantino and Phil McDonald from symmetry.
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Thanks gentlemen for joining us again, whether or not the market goes up
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or down when you have the long short overlay you have
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opportunities to to find losers losses.
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If you will to reach hard that tax benefit,
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it's some what counterintuitive right we're looking
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for Securities that have gone down in
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value, but I think the truth of the matter is is that when you
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own an ETF that's tracking an index or mutual
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fund that's tracking index. The reality is Phil
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you do own those losers. You just might not see them right? They're always
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that's right. Yeah looking at and that's
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a great Point looking at say in S&P 500 or
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Russell 1000 ETF. You you see one number,
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you know one one price
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one return but behind
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You're likely going to have dozens and dozens of positions
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that throughout the year and at year end
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are in or in a lost position. So in
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direct indexing, it just kind of breaks down that wrapper and
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you hold, you know hundreds of Securities directly. So
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you kind of see those a little bit more clearly sure and
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we've seen that in recent years right with some of these tech stocks
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the Fang stocks if you will Facebook Apple Amazon Netflix Google
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Etc. They were driving the returns of the S&P and there
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was a vast majority of those securities within the S&P that
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were in the red and by unwrapping it you can
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take advantage of those you still run into the issue of
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the portfolio seizing and what
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I mean by that is what we've been talking about having that portfolio
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get to a point where you don't have any room to make
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any trades without incurring some sort of tax consequence, but I
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think that's where the 1330 comes in right Glenn you're
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able to apply that strategy on
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top of an existing portfolio generate losses in
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any Market environment. And so
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So I think that that's a really interesting thing Glenn. Can you talk a little bit?
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I didn't mean to interrupt you, but could you talk a little bit about what is
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what happens with the risk exposure by putting that overlay on
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right investor with that 100 dollars 30 long
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30 short what what happens to the
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risk characters of that particular account? Sure. Yeah great
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question Tom. So if you look at if you just
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put on a 30% long 30% short
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portfolio. And you said what is the risk of
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that portfolio in isolation by itself? The answer
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to that is about one percent and that
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could be there be you know, standard deviation how much it's
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going to move around or it could be if you're if you're looking at that benchmarked
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to a you know, an index like
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the S&P 500 that would be one percent tracking here. So pretty
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modest, you know, a lot of active Equity strategies have tracking
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air easily of two percent or more. So we're
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not adding a lot of of risk just via that long
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short extension, but in reality as I mentioned you have
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these kind of Legacy accounts that
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Some elevated levels of risk that long short extension is
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a tool to reduce that risk. So even though
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you have a 1% risk in
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that long short extension in isolation. If you use that
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long short extension efficiently to reduce
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the total risk of the portfolio, then oftentimes we
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can also we can actually reduce kind of the total tracking
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error or risk versus The Benchmark of a
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tax less harvesting strategy often we can at least
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keep it the same. So when you look at a quantino kind
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of 130 30 tax loss harvesting account tracking errors
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typically one and a half percent on average
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and that's very very similar to what of
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what a clients are probably experiencing in their long only text less
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harvesting accounts as well. So just to reiterate what you're
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saying by applying the the 1330 extension to
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a portfolio the clients risk exposures still that
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principle investment is what I'm hearing you say,
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however, I think what I think a really really strong
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point is that it's not necessarily
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the risk by putting the overlay but it actually can be a risk mitigator Phil
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you and I have run across these many many times where investors
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come to us and we look at their existing Holdings
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and we're working on a Case right now
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where the investor who probably should
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have a balanced portfolio between Brawley Diversified
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stocks and bonds.
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Is stuck in a single stock position that they
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can't do anything with because of the
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fact that it's it's got such a low cost basis if
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they were to sell that security. They would be looking at some significant.
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Tax consequences, but only a single
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stock is a real risky Endeavor. Oh, no question,
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and I think
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This is such an incredibly powerful benefit of this
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strategy. And I think it it sometimes is you know
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mentioned second after the the tax Alpha
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and hey, you can keep more of what you earn but this is so
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incredibly powerful, you know, thinking of
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Really sad examples through time like Enron, you know things went
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very bad for people who held most of their company
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stock a lot of incentive plans. These
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days will give employees options and shares and
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all that. So this is an issue or a lot
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of investors and I think this solution really is, you know virtuous and
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really helping them in their Financial Health and just to
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maybe put a finer point on it and at the
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risk of being a little repetitive, you know, if you own a
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large amount of your, you know, large amount of your financial wealth
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is in an oil stock or a
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tech stock.
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Immediately in putting on the 13030 strategy
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the the 30 extension the
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30 more long can hold.
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Every other industry except that one you hold.
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Imagine that diversification and then the short can reduce
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that exposure to that one industry. So overnight in
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what in in the first, you know
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day of transactions you go from hey, I
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might end up like Enron or wow. My my
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financial wealth is gonna ride up and down with
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the price of crude oil or how Google does and
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immediately you're getting more
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of a diversified Market portfolio. Even if
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you're just shooting toward maybe an S&P 500 Index. It's immediately
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beneficial Glen. I don't know if you'd add
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anything to that but I really find that as you know, powerful benefit
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to the end investor. Yeah, the
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your correct fell the deals exchange solution that
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quantino offers is really a use case
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that came about from client feedback. We're fortunate to
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work with a lot of family offices. These are very wealthy families that
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have concentration in their portfolio.
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They built wealth via service to a public company or
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investing in a company that went public and eventually
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They want to turn the corner from you know,
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this this wealth that has been built by that concentration turning
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the corner toward wealth preservation and that
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means diversification. So how do we do that in a tax efficient manner?
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There's exchange funds that we you
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know that are really an option for very wealthy families, but
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really not for clients at scale. They're multi-million
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dollar minimums their private
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Fund Solutions and you know, you're vestly
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investing in a hedge fund that's gonna take seven years to diversify
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and they're very expensive. So we always knew
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that if we could use our capabilities to help clients diversify
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concentrated positions to be a pretty powerful thing and
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that 30 by 30 extensions the the way we do that so, you
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know, we put that long short extension on
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The extension generates tax benefits along the
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way we can use that extension to reduce the risk of
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that concentrated position. You're totally right there. And then
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over time as we generate those consistent tax benefits
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that gives us a mechanism to sell
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down that concentrated position, but we're always matching
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the tax benefits that we generate with the
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capital gains that we are realizing by selling down that
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position.
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And then once we sell we're rebalancing into a
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diversified index of the advisor and the client's Choice
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could be S&P 500. It could be Global stocks really whatever
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the asset allocation decision ends up
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being so yeah a typical even low basis very
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low basis position 20% cost basis. We
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can help diversify in a tax efficient manner
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in around seven years.
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That's very cool. It's a very clever strategy. I mean
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we're talking about tax benefits, but what we're really talking about is
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transitioning a
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Well, I would consider a concentrate risky portfolio very
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risky at times into something that
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is more suitable for that investor more Diversified but
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doing it in a way that they don't
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have to feel the the pain of unwinding
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those positions that might have some very significant embedded
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gains. You know it our
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industry we get
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picked on I guess for being very jargony right a lot
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of jargon and terms that a lot of folks that
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are not in this industry on a daily basis and
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we throw out the term tax Alpha quite a bit and
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I'll throw this question out to both the a Phil and Glenn.
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Can we just Define what tax Alpha is
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and then can you quantify it? Sure. Yeah. Yeah
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to us. I think of tax Alpha is
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tax savings.
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So, you know if if quantino generates
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a dollar of short-term
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capital loss.
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Then if you have a short-term gain
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a dollar of short-term gains, that saves you
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40.8 percent. So I've saved the client 40 cents
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41 cents in tax. If
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I'm using that short-term law stuff set long
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term gains that that long-term gains rate essentially 23%
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at the federal level. So I've
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saved clients, you know, 24 cents
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on that dollar of a capital loss.
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So if I can consistently generate Capital losses
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if quantino can consistently do that. We're letting
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clients offset the capital gains
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that they have in their portfolio.
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and they're just keeping more of the return from those capital gains
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year to year and those capital gains from can come from a lot of different,
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you know Avenues it could be
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Capital gains distributions from Mutual Funds. It could
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be long-term gains realized from rebalancing your portfolio
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Etc. So to me tax Alpha
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is keeping more of that return in the
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client's pocket paying less in capital gains and using those
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Capital losses as a vehicle to do that great.
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That's a that's a very eloquent definition of
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taxol. Do you care to add that? Yeah. I I like that
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definition as well. Yeah. One thing I'd say is
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that I think there's again pretty broad agreement
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that long only tax loss harvesting
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does have a benefit to the portfolio
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and it might be, you know one to two percent maybe maybe
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two percent on you know, really good implementations call
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it one percent. But again that has a
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horizon that's gonna likely track down as your portfolio
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ossifies seizes up turns into
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our favorite word. No, you know,
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nothing with unrealized gains. So, you know,
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you're talking 1% dish in
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Long only tax less harvesting type of tax Alpha that
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that is going to go away in a handful
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of years, right? Thank you for that. One of
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the the questions and this is gonna go really to
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investment vehicle more so than anything else. I've heard
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investors say like 2022 for instance.
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Horrible, no good very bad year for investors Equity fixed
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income both down investors who hold actively
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managed mutual funds.
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having negative return
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But they also got a pretty hefty tax bill
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in some scenarios right capital gains distributions in
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December. So Phil when investors
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are looking at open-ended mutual funds what are
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some of the things that they should be considering from a tax efficiency standpoint,
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you raise a good point and to some extent
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those examples of you know, being down and
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having a gains distribution. That's an unlucky
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combination of a handful of things right like it comes
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down to perform some fun what the
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Redemption level was how the fun generates cash
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to meet those redemptions and whether
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or not that's kind of gain realizing
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lost real estate realizing or neutral history of
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the mutual funds experience can maybe give you
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some insight into that as well as the strategy whether
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it's going to be, you know tax efficient in
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a neutral kind of scenario and whether
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it's you know, growing or stable
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as opposed to, you know, shrinking with a lot of redemptions.
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you mentioned tack sorry investment vehicles so very often
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we
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We compare mutual funds and ETFs and there are some important differences
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there on the income side, they're pretty
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even right funds all funds have to distribute income and
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they can choose the frequency with which they do that. Some of
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the differences really come into play with capital gains
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realization. Now mutual funds to me
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to Redemption they have to do that with the cash in the fund. They might
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have enough cash. They might need to sell to realize that
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to fund that Redemption and some of
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the things I mentioned earlier, you know, whether they have enough cash what
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their tax Lots look like how their age
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how they're Diversified how the fund's been performing, you know
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frequency and magnitude of redemptions all that will
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kind of impact whether or not you're end. They have realized
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game they need to distribute or not with ETFs.
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There's a little more complexity in how they're traded
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and some of the some of the capital gains efficiencies.
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So you and I can trade an ETF
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on an exchange and that doesn't involve the fund at all, you know, you
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sell share I buy a share from you and
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The fund's not involved funds doesn't need to find cash pretty
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simple. But there are some transactions that do
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involve the fund, you know, something called authorized participants help
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ETFs trade efficiently
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and sometimes they'll redeem directly with the fund the
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ETF the ETF has a choice
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to you know, redeem in kind or give Securities to that
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redeeming entity, right and in
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doing that there's no transaction. There's no realization
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of of gains and it gets
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even more interesting because that the fun can choose
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which shares to redeem out and they can often redeem
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out the lowest cost basis shares. Thereby, you
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know creating a very tax efficient fund vehicle.
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The investors still needs to pay tax on their gain
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if they sell their shares, right, but the
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fund itself can get pretty creative in
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in reducing cap games realization. So,
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you know, it depends sometimes on the strategy, you know,
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fixing strategies might not be as
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Efficient in an ETF as as Equity strategies and some
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mutual funds can certainly be very tax efficient. So, you know,
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it comes down to you know, I think education getting the
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right investment strategy and then, you know also choosing the right vehicle
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now, that's that's really interesting and we've had conversations
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on the differences between ETFs and mutual funds on
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this podcast. And what's really fascinating to me again,
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I'm gonna use the term convenient byproduct the creation of
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redemption process of an ETF isn't designed
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for tax efficiency. It's designed to
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making sure that the
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nav is equal to the underlying basket of
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stocks in that process in itself makes ETFs
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extremely tax efficient.
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So it's not the goal but it is is something
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that you get through that process, which is interesting. Okay,
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so just kind of recap here for
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our investors.
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When considering your tax status with your
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portfolios consider what we call an evidence-based
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investment philosophy Buy and Hold that
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tends to lead to not only a greater likelihood of outperformance
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by staying the course, but it
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reduces frictions reduces transactions in
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the portfolio. Thus leading to a higher level of tax efficiency consider
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the vehicles that you're using when using
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open-ended mutual funds gravitate towards
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more passively managed growing mutual
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funds ETFs certainly have tax benefits and
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for those investors that are deploying a
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direct indexing strategy. There's certainly more
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opportunities through the sheer number of names to identify losses
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to perform ongoing tax loss harvesting
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and then lastly Glenn against thanks for
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joining us adding a long short
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extension a 1:30 strategy certainly can
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help not only from a diversification standpoint,
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but also from
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Alpha generating strategy. So Glenn.
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Thank you so much for your time Phil. Thank you for joining us
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here for our listeners. Thank you for for listening to
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us. You can access this podcast and all of
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our podcasts and our series anywhere you get your podcasts and
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I look forward to our conversation next time. Thank you
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so much gentlemen, thank you. Thanks Cemetery Partners. LLC
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is an investment advisor firm registered with
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the Securities and Exchange Commission The Firm only
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endorsement of the firm by the commission. No one
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should assume that future performance of any specific investment investment
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strategy product or non-investment
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related content made reference to
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directly or indirectly in this material will be profitable.
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As with any investment strategy there is the
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possibility of profitability as well as loss due
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to various factors including changing market
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conditions and/or applicable laws.
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Content may not be reflective of current opinions
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is provided for educational and background use
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information contained in this material serves as
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the receipt of or as a substitute for
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personalized investment advice.
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