No one likes a down market, but big pullbacks are proving to be a good opportunity for advisors to finally sell out of long-held mutual fund positions and move client into ETFs without risking a major tax hit.
Capital gains can be a big barrier to advisors who are interested in moving client money from long-held mutual funds to more efficient ETFs, particularly in fixed income, industry executives told Financial Advisor IQ’s sister publication, Ignites.
But the steep drop in bond prices during the first half of the year mean that advisors can reap the benefits of tax-loss harvesting to make big portfolio shifts like never before, Vanguard’s Ryan Barksdale explained to Ignites.
Advisors can use tax-loss harvesting in a few ways, analysts and executives said. One option is to move the assets from money-losing funds into ETFs, directly. Alternately, FAs can use losses in one part of the portfolio to offset the impact of gains from other funds, and then move those appreciated fund assets into ETFs.
A look at mutual fund and ETF sales trends suggests some investors are already moving money between wrappers.
The redemptions from fixed-income funds so far this year are massive: more than $205 billion as of June 30, according to Morningstar Direct data. Of that, $137.5 billion was pulled out in the second quarter, making the three-month span the second-worst sales quarter on record since 1993. The only period when bonds bled more was the first quarter of 2020, when the pandemic spurred volatile markets.
Sales of taxable bond ETFs have slowed, but the products still attracted $53.8 billion in net new money during the first half, according to Morningstar’s database.
ETF shops, for their part, have made helping advisors transition portfolios to ETFs a value-added service. Shops are offering support ranging from providing tools to examine the potential gains and tax benefits of a specific trade, to full-blown portfolio analyses and consulting services.
But before shifting client money, advisors should consider a few key factors, ETF sponsors and analysts say. For one, you want to make sure you move out of mutual funds before year-end capital gains get distributed in order to avoid another layer of taxable income. Advisors also need to make sure they are not putting money cashed out of mutual funds into ETF clones or “substantially identical” ETFs in order to avoid triggering a wash-sale, which would wipe out any tax-loss harvesting.
But for advisors who have been waiting for the right moment to get their clients to make the switch to ETFs – or responsibly respond to clients’ desires for more of these products in their portfolios – now might be time to make lemonade out of the sour fruits of the stock and bond markets.