INSIGHTS

On November 14, 2016

Tax Swaps - It’s Never Too Early….

Though it’s never a great conversation to have with investors, the silver lining of losses associated with portfolio holdings is the opportunity to create tax loss swaps. One of the important aspects of the swap is obtaining market liquidity on the sale of bonds held in a portfolio. If history is any guide – which it usually is – we can expect an increased volume of investors looking to sell bonds as we approach the end of the year.

We encourage investors to avoid being further negatively affected by the rush to the exits. Specifically, start the process early in an effort to have the potential for better relative performance.

Let’s consider the situation as follows. Much like the rush for the exits at the end of a movie, as we approach year-end, investors will more aggressively seek to sell bonds with losses to use for tax purposes. The closer we get to the end of the year – and the more investors are seeking such liquidity – the more the spreads can be expected to widen. This widening spread could potentially unnecessarily add to the losses for the investor.

The cost to the investor for waiting longer to seek liquidity is the increased market-spread as a result of a cost of seeking liquidity at the same time as many others. Furthermore, Dealers often run into balance sheet constraints and “window dressing” issues with regard to capital at the end of the year. Therefore, there may be less of a willingness for the market to provide spreads as tight as would otherwise be expected.

As students of the markets and human behavior, we have observed several patterns over the years. Humor us with our theory:

1. Investors are human (perhaps a bit of a stretch but we did ask for you to humor us).


2. Behavioral finance suggests that investors typically fall into predictable patterns of behavior.


3. There is a finite amount of time for investors seeking to monetize tax-loss swaps for the 2016 tax year.

Our prediction is that investors, as a group, bowing to their human nature, will delay the execution of tax-loss swaps until later in the year. Since December 31, 2016 is the cut-off date to realize the loss, such activity will steadily increase until we reach the last few days of the year.

We suggest starting the process now for seeking liquidity on tax-loss-swaps. Avoid the rush to the exit and take a leisurely stroll by getting a head-start on the rest of the market, and have the potential to benefit with better relative performance than the investor who waits until the last moment…. After all, we have seen this movie before and we already know how it ends.

CRN: 2016-1108-5627R

AAM was not involved with the website linked to in this piece and the opinions expressed are not necessarily those of AAM.

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. For additional commentary or financial resources, please visit www.aamlive.com.