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Rate Moves Provide Big Fixed Income Tax-Loss Harvesting Opportunities

Today’s market activity underscores that tax-loss harvesting should be a strategy implemented throughout the year. If you harvest losses only at yearend, investments that were down early in the year could have bounced back into positive territory — resulting in missed opportunities to sell losers and book losses to offset realized gains.


Head of SPDR Americas Research

After a sharp move in rates over the past week following a larger than expected CPI print, the US 10-year yield breached 2% for the first time since 2019. This has put downward pressure on bond portfolio returns; the Bloomberg US Aggregate Bond Index (Agg) is down 4.05% for the year.1 Having posted a 1.54% loss in 2021, the Agg could be on the way to breaking its multi-decade streak of never posting back-to-back years with losses.2

While negative fixed income returns may have investors down, this challenge also presents an opportunity. Tax-loss harvesting — the act of selling a security in a taxable account at a loss and using the loss to offset realized taxable gains to help reduce taxes — can be a silver lining in this higher rate regime.

In fact, we’re looking at one of the most significant tax-loss harvesting opportunities in years.

Quantifying the Harvest

Based on price returns, 92% of fixed income ETFs are trading at a loss for the year.3 And when compared to the funds’ high-water mark over the past year, that number increases to 100%4 — meaning every bond fund in the US-listed ETF market likely has a negative return no matter when you bought it in the past year.

Moreover, most bond ETFs are trading at a steep loss. As shown below, 77% are down more than 4% from their one-year high-water mark. Extend the horizon to a three-year lookback, and the number increases to 84%.

Percent of Funds with Losses

Across a variety of timeframes and thresholds, $1.2 trillion of fixed income assets now sit in a loss position.Of course, not all of those assets are really underwater given that investors may have purchased shares many years ago.

Analyzing fund flow trends can help to fully quantify the breadth and depth of these losses. As shown below, so far this year $180 billion has flowed into funds that are currently in a loss position relative to their one-year high-water mark. Extend the horizon to the three-year high-water mark, and $552 billion is likely at a loss.

Fund Flows Based on Loss Thresholds

While the depth of losses is significant, certain bond sectors are feeling more pain than others — particularly when the time horizon and thresholds are adjusted. For instance, as shown below, over the past year, within the Aggregate sector $71 billion has flowed into funds that are trading at a loss on a one-year lookback — and the average return on those funds is -6%.

The more rate sensitive sectors — Aggregate, Inflation-Protected, and Government — represent the largest tax-loss harvest opportunities.

Fund Flows versus Average Return By Sector

Harvest to Swap or Refine Exposures

Traditionally, after selling the losing position, investors have used a “tax swap” — a similar but not identical security — as a placeholder to maintain exposure to the asset class for 30 days. After 30 days, they choose whether to switch back to the original holding.

Keep in mind that if the new investment appreciates and you sell it within a year, those gains will be taxed at the short-term capital gains tax rate, which is higher than the long-term rate. For that reason, it may be advantageous to choose a swap that could become a long-term holding.

Answering these three questions can help you decide whether to use a temporary swap or to employ a new strategy:

  • Do I still have conviction in the original asset class?
  • Would using a different strategy better position the portfolio?
  • Can I lower my portfolio expenses?

To guide your decision-making, please contact your SPDR ETF Regional Consultant to discuss how we can help. Our portfolio analysis service offers portfolio-level insights by looking through every fund at the individual security level. Examples of insights gained from this analysis include fundamental characteristics, sector, country, credit rating, and duration exposures, stress tests, and more.

Whether you choose a swap or more permanent replacement, remember that ETFs generally have lower expense ratios than mutual funds do.6 Also, by nature of their unique create and redeem functions, ETFs are inherently more tax-efficient vehicles than mutual funds are as they typically do not distribute capital gains as often as mutual funds do.7

Tax-Loss Harvesting Rules

In taxable accounts, when you sell a position that has lost value, you can use the loss to offset capital gains that result from selling securities at a profit during the year. Your booked losses can also offset funds’ annual capital gain distributions.

At year-end, if your capital losses exceed your gains (or if you don’t have any gains), your losses can offset up to $3,000 in non-investment income, even though that is often taxed at a higher rate than capital gains are. Losses greater than $3,000 carry forward and can be used to offset capital gains and ordinary income over your lifetime.

Importantly, when reinvesting the sale proceeds, you must abide by the Internal Revenue Service’s Wash-Sale Rule, which prohibits claiming a loss on the sale of an investment if the same or “substantially identical” investment is purchased either 30 days before or after the sale date.

Why Harvest Now

Today’s market activity underscores that tax-loss harvesting should be a strategy implemented throughout the year. If you harvest losses only at yearend, investments that were down early in the year could have bounced back into positive territory — resulting in missed opportunities to sell losers and book losses to offset realized gains.


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