The following table illustrates the value of tax-loss harvesting, showing a scenario for a five-to-15-year ladder under various interest rate increases over a one-year horizon. It provides pretax performance, value added from tax-loss harvesting, and performance after considering the tax benefit over a five-year period.
For example, if yields increase by 1% over the next year on a five-to-15-year ladder, pretax performance will be approximately 6.16% on a cumulative basis over five years. Optimizing loss-harvesting opportunities, however, can generate approximately 3.32% of tax alpha. This results in higher after-tax performance of 9.48% over that five-year period.
Estimated five-year cumulative total municipal bond returns
Sources: Parametric, Thomson TM3-MMD Data. Current MMD yield curve as of 4/19/21. The scenarios presented above are hypothetical and provided for illustrative purposes only. They should not be relied upon to make investment decisions. The scenarios do not reflect the experience of any investor, nor do they project the performance of any investment strategy offered by Parametric. Each scenario reflects the performance of an equal-weighted laddered portfolio consisting of municipal bonds, rated BBB or higher, with consecutive maturity dates ranging from five to 15 years purchased on 4/19/21. The scenarios assume an investment amount of $1,000,000, average duration of 8.67 years, and an average starting yield of 1.39%. The scenarios assume a parallel yield-curve shift and short-term capital gains rate of 40.8%. State and local taxes are not included in the calculations. The pretax and tax benefit returns are calculated using the weighted return of each bond. Losses are harvested systematically based on bond maturity, size of the loss, and wash-sale rules and assuming suitable bonds are available for replacement. This information does not reflect the impact of fees or expenses on the portfolio, which would reduce returns. All investments are subject to the risk of loss. Additional information is available upon request.
Ongoing year-round tax-loss harvesting provides additional tax alpha by minimizing capital gains taxes. An active, data-driven tax-loss management strategy maximizes loss-harvesting opportunities and minimizes costs. Careful analysis of each trade helps ensure portfolios maintain their structure and characteristics without violating wash-sale rules.
The bottom line
A professionally implemented rules-based tax-loss harvesting strategy allows investors to capitalize on loss-harvesting opportunities throughout the year, rather than just at year-end. This eliminates the hassle of year-end manual requests while also optimizing the timing of sales for more favorable liquidity and new-issue volume. A year-round tax-loss harvesting strategy helps deliver tax alpha while maintaining desired exposure to the asset class at no additional cost.
The scenarios presented are hypothetical in nature, do not reflect actual investment results and are not guarantees of future results. No representation is being made that any account, product, or strategy will or is likely to achieve profits, losses, or results similar to those presented. Hypothetical or simulated performance results have several inherent limitations. Unlike an actual performance record, simulated results do not represent actual performance and are generally prepared with the benefit of hindsight. There are frequently sharp differences between simulated performance results and the actual results subsequently achieved by any particular account, product, or strategy. In addition, since trades have not actually been executed, simulated results cannot account for the impact of certain market risks such as lack of liquidity. There are numerous other factors related to the markets in general or the implementation of any specific investment strategy that cannot be fully accounted for in the preparation of simulated results and all of which can adversely affect actual results.
Parametric does not provide legal or tax advice. Please consult your tax and/or legal counsel for specific tax or legal questions and concerns. The default tax rate of 40.8% represents the highest federal marginal tax rate (37%) plus the Medicare Tax for top earners (3.8%). Other taxes such as the Alternative Minimum Tax, Medicare Tax Surcharge and Self Employment Tax cannot be accurately computed based solely on taxable income and are therefore ignored. It is possible that these additional taxes could impact an investor’s marginal tax rate.
Investors should consult with their own tax or legal advisor prior to entering into any transaction or strategy described herein. All investments are subject to risk, including the risk of loss. Investing in the bond market is subject to risks, including market, interest rate, issuer, credit, inflation risk, and liquidity risks. The value of most bonds and bond strategies is impacted by changes in interest rates. Bonds and bond strategies with longer durations tend to be more sensitive and volatile than those with shorter durations; bond prices generally fall as interest rates rise, and the current low-interest-rate environment increases this risk.
Current reductions in bond counterparty capacity may contribute to decreased market liquidity and increased price volatility. Bond investments may be worth more or less than the original cost when redeemed. Income from municipal bonds may be subject to state and local taxes and at times the alternative minimum tax; a strategy concentrating in a single or limited number of states is subject to greater risk of adverse economic conditions and regulatory changes.