INSIGHTS

On November 09, 2015

AAM Viewpoints - It’s Time to Start Evaluating Bond Tax Swaps

Investors have less than two months to identify and harvest any tax losses for 2015, and since December typically presents some liquidity challenges now is the time to start planning. Although we haven’t seen the large returns this year that we witnessed last year in fixed income assets, there are opportunities to improve portfolio composition. A bond tax swap allows an investor to take advantage of a tax loss while maintaining or enhancing the income, credit quality, call protection or duration of their bond portfolio. While the opportunities in this year’s swap season may not be as obvious as last season (see Barclays performance table below), opportunities still exist and we encourage investors to move sooner rather than later. As previously mentioned, liquidity typically deteriorates in December and swaps remain most effective when the bid-offer spreads are tight (intense price competition on both the buyers’ and sellers’ sides) so now is the time to consider implementing a swap strategy to address anticipated tax liabilities.

Source: Barclays Live

Past performance is not indicative of future results

As you can see, in 2015 we’ve seen positive performance in most asset classes so the swap opportunity may be credit driven in which you may have had a downgrade or an individual credit that has performed poorly. Swapping selected holdings into a new credit that fits your risk profile, while improving portfolio credit quality or tactically adjusting duration, may allow a portfolio to be better positioned for the anticipated rate environment. Current market conditions allow for many types of swap opportunities that have the potential to enhance portfolios. A few types of swaps that might be beneficial include:

• Credit Quality Swaps
• Total Return Swaps
• Duration Swaps
• Income Oriented Swaps
• Tax Efficiency Swaps
• Asset Allocation Swaps

Virtually any type of bond can be swapped so long as an appropriate replacement can be found, but remember the replacement bond must be substantially different than the bond to be swapped to avoid disallowance of the loss under the “Wash Sale Rule.”

As an example, if there is a loss on a bond, one can sell that bond and simultaneously purchase a bond within 30 days which provides the same investment objective to the portfolio but is “substantially different.” The standard rule of thumb is two of the following three characteristics below must be different and it’s important to ask a tax professional for input.                          

• Coupon Rate
• Issuer
• Maturity

With less than two months left in 2015, identifying and harvesting losses now could provide you the opportunity to avoid the challenging markets we typically see in December. This strategy is not only useful for addressing potential tax issues, but allows the potential to improve fixed income composition of your portfolio and take advantage of changing market conditions or investment objectives.

CRN:  2015-1102-5021R

Advisors Asset Management, Inc. and its representatives do not provide tax advice. Laws applicable to tax-related investment strategies can be complex and are subject to change. You should consult your own tax advisor before making any tax-related investment decisions.

All information and opinions contained in this publication were produced by Advisors Asset Management, Inc. (AAM) and other sources believed to be accurate and reliable. By providing this general information, AAM makes neither a recommendation as to the appropriateness of investing in fixed income securities or using a tax swap investment strategy. Tax swaps are not for everyone. Using a tax swap strategy has many risks so it is recommended that you seek counsel from both a financial professional and a tax advice professional. AAM is not providing any specific investment advice for any particular investor. Additionally, due to rapidly changing market conditions and the complexity of investment decisions, supplemental information and other sources are required to make informed investment decision based on the investor’s suitability specifications. AAM and its representatives do not provide tax advice.

This commentary is for informational purposes only. All investments are subject to risk and past performance is no guarantee of future results. Please see the Disclosures webpage for additional risk information at https://www.aamlive.com/legal/commentary-disclosures. For additional commentary or financial resources, please visit www.aamlive.com.