While December typically is when a flurry of last-chance tax-loss harvesting takes place, this year the added factor of stockpiles of cash sitting on the sidelines has some managers at Capital Group encouraging advisors to rebalance portfolios at the same time.
“Holding cash when the Fed is done hiking has historically not been valuable for shareholders and clients,” said Courtney Wolf, fixed-income portfolio manager in charge of several offerings, including the firm’s relatively new core intermediate municipal bond ETF. “I would not encourage people to stay in cash today, given that historically it's not been beneficial for them at this point in the cycle.”
Wolf—who along with David Hoag, another fixed income portfolio manager, spoke last week at the investment firm’s webinar “ETF Ideas for 2023 and Beyond”—also agreed to a follow-up interview to dive more deeply into her perspective.
She said that this year tax-loss harvesting activity has seemed somewhat muted compared to prior years, the result of ongoing uncertainty in both the equity and fixed income markets.
“There’s been some hesitency to make big decisions, and I think this is probably also consistent with why there's a tremendous amount of cash on the sidelines,” she said. “We've had pretty meaningful volatility in the macro environment over the last couple of years. Particularly on the fixed-income side, it's been a really volatile market.”
Instead of leaning into a wait-and-see approach, Wolf said she recommends advisors and investors act now to move cash one step over into fixed income, where some duration on interest rates can be had.
“You could move into a longer duration asset class. Something like fixed-income core plus income (CGCP) would be a good example. Or CGMU is the muni offering,” she said. “That is a duration of about five years and a yield to worst of around 4%. For someone who's in the highest income tax bracket, you get to a taxable equivalent yield of above 6.5%. Again, for a duration of about five years. That feels pretty interesting to me today.”
During the webinar, Hoag, who runs the core plus ETF for Capital Group, agreed with Wolf’s strategy at this point in time.
“The Fed is close to being done, and we've had a very flat to inverted curve for a good part of this year. The next reaction for the yield curve will be to steepen, for two reasons,” he said. “One is slowing economic conditions and inflation moving back into target. It gives the Fed room to stabilize rates or actually lower rates and still maintain a slightly restrictive stance. And two is I think term premium could go up. And the reason term premiums—just the amount you're paid to take on more interest rate risk—could go up has to do with the deficits that we're running and the amount of financing that the U.S. needs to do. We do like a full complement of duration, but really try to get that duration focused on the two- to five-year part of the Treasury curve.”
Strategies for using fixed income in tax-loss harvesting include extending that tax efficiency by rebalancing a portfolio into other tax-efficient options, like Wolf’s muni bond fund, she said. Tax efficiency is one of the three key attributes of an ETF, alongside transparency and liquidity.
“With the ETF structure, there are more tools to manage capital gains. I really like the ETF wrapper for that,” she said. “We're really careful about capital gains. As we think about actively managed ETFs, there are times when a bond has done really well that we want to sell that bond and redeploy it into a bond that has not done as well. We're actively thinking about which bonds are best in the portfolio and which are the cheapest. We can use some of the tools available in the ETF to manage capital gains that way.”