This post was written with contributions from Martin Dunn. Martin is a Research Analyst in the ETF and Mutual Fund Research Team.
Articles about tax loss harvesting show up like clockwork every year towards year-end, but they often miss an essential point: harvesting tax losses is a year-round activity that should be incorporated into your ongoing tax planning strategy. These articles also tend to overlook the importance of harvesting losses not only on the stock side of your portfolio, but also on the bond side. With interest rates rising and bond prices falling, investors may want to take a closer look at their bond portfolio now, to see if they are sitting on unrealized losses to potentially take advantage of a summer harvest.
Downward sloping bond prices
Well before the Federal Reserve entered its monetary tightening cycle in 2015, bond prices had begun to witness periods of declines. Most noticeable was the “Taper Tantrum” in 2013, when then-Federal Reserve Chairman Ben Bernanke suggested the central bank might begin tapering bond purchases during the year. But as the charts below demonstrate, this process intensified once the Fed started raising interest rates in earnest in December of 2016. These price declines are widespread as well, taking place across multiple maturities and bond sectors.
The first chart shows the index price levels, essentially the market cap weighted value of the bonds within the index expressed as a single value, versus the rise in the US 10 Year Yield. This clearly depicts the trend of falling prices.
The second chart shows the rolling index price returns versus the rise in the US 10 Year Yield. This clearly depicts the severity of falling prices on returns for a particular time frame. These returns do not, however, indicate the potential loss if an investor still has an allocation today. The extent of the losses today is where more research was needed.
The extent of bond losses
The extensive nature of dropping bond prices means a wide swath of investors could be holding bond exposures that have dropped in price since being purchased. Just how wide a swath? We decided to run the numbers to find out.
To do this, we:
- Examined the 30 largest fixed income ETFs by assets under management.
- Analyzed rolling price returns for those ETFs from December 31, 2012, to June 30, 2018. Price return is used as taxes are calculated based on a bond ETF’s price return—its purchase price vs. its selling price—and not total return, which takes into account dividend payments from the underlying securities coupons.
- Moved forward in one-month increments (e.g., January 2013 to May 2018, February 2013 to May 2018, etc.), creating more than 60 timeframes to study to replicate different potential holding periods.
These rolling periods provide a glimpse into ETF investors' potential current price returns for any probable period in the last five years, and this is what we found:
- 2 of the 30 largest fixed income ETFs had losses in 100% of the periods analyzed, representing $28 billion in ETF assets!
- 15 of the 30 largest fixed income ETFs had losses in 90% or more of the periods analyzed, representing $253 billion in ETF assets!
- 21 of the 30 largest fixed income ETFs had losses in 80% or more of the periods analyzed, representing $342 billion in ETF assets!
If investors in the big funds have potential losses, then it is more probable than not to infer that investors holding funds outside the 30 largest might be sitting on losses as well. To drive this point home further, we replicated the analysis of ETF positions with indexes as well. From investment grade to Treasuries to mortgages, every single bond index we tracked showed losses in nearly 100% of the periods we analyzed. Below is a subset of the exposures we analyzed and it paints a very different picture than broad based equities. With gains in equities and losses in bonds, investors could offset the two during this harvest—depending on magnitude of position.
ETFs for tax loss efficiency
We identified a large bushel of potential losses to harvest, from areas of the market such as traditional aggregate bonds, to bank loans, to mortgages, and investors can use the proceeds from selling their current bond ETF to move into a comparable SPDR® ETF that may provide either a lower expense ratio or improved exposure to position for a challenging bond market environment.
The following SPDR ETFs provide targeted bond market exposure to consider during this year’s harvest:
- Intermediate term bond exposure: The SPDR Portfolio Aggregate Bond ETF (SPAB) and/or the SPDR Portfolio Intermediate Term Corporate Bond ETF (SPIB). These ETFs are part of our suite of ultra-low-cost SPDR Portfolio ETFs™. For active management, consider SPDR DoubleLine Total Return Tactical ETF (TOTL)
- Short term bond exposure: The SPDR Portfolio Short Term Corporate Bond ETF (SPSB), which is also part of the SPDR Portfolio ETF suite, or rotate from fixed to a floating rate exposure with SPDR Bloomberg Barclays Investment Grade Floating Rate Note ETF (FLRN). For active management, consider SPDR DoubleLine Short Duration Total Return Tactical ETF (STOT).
- Intermediate government and mortgage bond exposure: SPDR Bloomberg Barclays Mortgage Backed Bond ETF (MBG) and SPDR Bloomberg Barclays Intermediate Term Treasury ETF (ITE)
- High yield or bank loan exposure: SPDR Bloomberg Barclays High Yield Bond ETF (JNK) and SPDR Blackstone / GSO Senior Loan ETF (SRLN)
- Emerging market debt: The SPDR Bloomberg Barclays Emerging Market Local Bond ETF (EBND). For active management, consider the SPDR DoubleLine Emerging Market Fixed Income ETF (EMTL).
Tax loss harvesting: What you need to know
Before breaking out the tractor for this harvest, it is important to understand these three points with respect to tax loss harvesting prior to making any investment decision:
- The Internal Revenue Service’s Wash-Sale Rule prohibits taxpayers from claiming a loss on the sale of an investment if the same or “substantially identical” investment is purchased within 30 days before or after the sale date.1
- Rather than sit on the sidelines, you can use a “tax swap”—a similar but not identical security—as a placeholder to maintain your exposure to the asset class for 30 days.
- After 30 days, you can choose whether to switch back to your original holding, or continue to hold the new one.
For more information on available SPDR fixed income ETFs or tax loss harvesting, you can visit our website or contact your SPDR ETF Representative on 1.866.787.2257.
1Internal Revenue Service, “Publication 550: Investment Income and Expenses,” as of 9/14/2016
S&P 500 Index
The S&P 500, or the Standard & Poor’s 500, is an index based on the market capitalizations of 500 large companies having common stock listed on the NYSE or NASDAQ. The S&P 500 index components and their weightings are determined by S&P Dow Jones Indices.
A method of crystallizing capital losses by selling losing positions and purchasing companies within similar industries that have similar fundamentals.