This year is shaping up to be one of the most difficult years financial advisors have faced, but if the market is giving you lemons, it is not too late to make lemonade. In fact, now might be a good time to take proactive steps to reposition client portfolios, especially within fixed income.
With the exception of commodities, every major asset class is down on the year, and many are down significantly. What is most challenging is that both stocks and bonds are down at the same time. Simply put, bonds are not protecting against a drawdown in stocks. In fact, they are a drag on portfolio returns year-to-date.
The Bloomberg U.S. Aggregate Index is off to its worst start since its inception in 1976 (Source: Bloomberg Finance L.P.). While most advisors do not rely solely on the Aggregate for fixed income exposure, all bond sectors are down on the year. The longer the duration, the worse funds have performed, given the rising rate environment.
According to the SPDR Americas Research Team:
• 96% of bond ETFs are trading at a loss this year with an average total return of -8%.
• 100% of the mutual funds in the Morningstar categories of Intermediate Core, Short Term Bond and Corporate Bonds have year-to-date losses.
• 55% of active mutual funds in the Intermediate Core category are trading at a loss and underperforming their benchmark.
For years, many investors only thought about tax loss harvesting—the practice of selling a security in a taxable account at a loss and using the loss to offset realized taxable gains to help reduce taxes—in the month of December for year-end planning purposes. Additionally, many investors have historically only looked at their equity positions for tax loss harvesting opportunities.
Bonds have not presented as compelling a case for tax loss harvesting in the past because they were not often trading at a loss; and when they were, they were not down significantly. In 2022, that has changed. With considerable losses from bonds year-to-date, it makes sense to consider the fixed income portion of a portfolio as a source for tax loss harvesting and to do so now rather than waiting until the end of the year.
The silver lining is that this opportunity to harvest losses within bonds comes at a time when fixed income allocations are prime for repositioning. With rates rising, financial advisors can sell higher-cost legacy mutual funds and buy lower-cost ETFs with similar objectives. The median expense ratio of mutual funds is 0.81%, while the median expense ratio of ETFs is only 0.50%, and there are a considerable number of large and liquid ETFs with expense ratios less than 0.10% (Source: SPDR Americas Research, Morningstar). In addition to negative performance, investors in fixed income mutual funds may face another setback—the potential for higher capital gains distributions, as portfolio managers may be forced to sell their holdings to meet redemptions.