Model Portfolio & SMA Strategists Showcase - Flipbook - Page 34
SMAs & MODEL PORTFOLIOS
tax-management strategies described
throughout this chapter. Years of
disciplined tax-loss harvesting inside
a direct-indexed account add genuine
value if the client plans to spend from
the account, gift appreciated shares
during their lifetime, or sell positions
before death for any reason.
But for a client whose actual plan is to
hold the bulk of the account until death
and pass it to heirs, the harvested
losses matter less than they appear to in
isolation, since the eventual basis reset
at death would have eliminated much of
the embedded gain regardless of how
actively it was managed along the way.
This doesn’t make tax-loss harvesting
worthless for an older, estate-focused
client. The harvested losses can still
offset gains realized elsewhere in the
portfolio during their lifetime.
But it does mean the conversation
about how aggressively to manage an
older client’s account should explicitly
account for the client’s actual intent,
whether that’s spending it, gifting it,
or holding it for heirs. Each answer
points toward a different level of taxmanagement intensity, and assuming
maximum harvesting is always the
right answer skips a conversation this
chapter’s own logic argues should
happen directly.
LONG/SHORT TAX-LOSS
HARVESTING
A more sophisticated technique,
generally reserved for larger accounts
and more active tax-management
mandates, uses paired long and short
equity positions specifically to generate
harvestable losses in both rising and
falling markets. The mechanics are
counterintuitive at first. Rather than
owning only long positions, a manager
holds long positions in securities
expected to perform well and offsetting
short positions in others, constructed
so that the overall market exposure of
the combined book still closely tracks
the target index or strategy.
The tax benefit comes from the
fact that a long position and a short
position respond oppositely to
the same market move. In a rising
market, the short side of the book
generates losses even as the long side
generates gains, losses that can be
harvested to offset gains elsewhere
in a client’s broader portfolio, all
while the combined long/short
position continues to track the target
benchmark’s overall return.
This means a long/short tax-managed
account can continue generating
harvestable losses even during a
strong bull market, a period when a
conventional long-only direct-indexed
account has largely run out of losses
to harvest, as the tapering effect
discussed above describes.
This technique isn’t for every client.
It requires a prime brokerage
relationship, carries additional
financing and trading costs on the
short positions, and introduces gross
market exposure considerably higher
than the account’s net exposure would
suggest, meaning the operational
and risk complexity is real, not just a
marketing wrinkle. It belongs in this
guide as the sophisticated end of the
tax-management spectrum.
It’s worth knowing this exists and
roughly how it works, and worth
bringing in a specialist conversation for
any client where the tax situation might
actually justify the added complexity,
rather than something to attempt as a
first tax-management strategy.
FIXED-INCOME TAX-LOSS
HARVESTING
Everything discussed in this chapter so
far has been implicitly equity-focused,
and that’s worth correcting directly.
Tax-loss harvesting isn’t exclusively
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an equity technique. Bond portfolios
can be, and increasingly are, actively
harvested for tax losses using largely
the same underlying logic, though the
mechanics differ enough to deserve
their own explanation rather than being
assumed identical to the equity version.
The core difference is what counts
as a “substantially identical” security
for wash-sale purposes. Two shares
of the same company’s stock are
identical. Two bonds from the same
issuer with different coupons, maturities,
or issuance dates generally are not,
which gives a fixed-income manager a
considerably larger universe of genuinely
different-but-similar securities to swap
into after realizing a loss, without the
wash-sale rule blocking the trade. The
other major difference is what actually
drives losses in the first place.
Equity losses are driven primarily by
company-specific and broad market
volatility, while bond losses are driven
mostly by interest rate movements,
meaning a rising-rate environment,
often treated as bad news for a fixedincome portfolio generally, can actually
be a rich source of harvestable losses
for a tax-managed bond SMA, even
while core bond values are falling.
This matters directly for the municipal
bond SMA discussion elsewhere in this
guide (p. 27). A municipal bond ladder
built with active tax management in
mind isn’t just about credit selection
and state-specific tax exemption. It’s
also a genuine tax-loss harvesting
vehicle in its own right, particularly
during periods of rate volatility.
Advisors serving fixed-income-heavy,
tax-sensitive clients, often exactly
the retirees and near-retirees this
asset class is built for, should ask a
bond SMA provider directly whether
active tax-loss harvesting is part of
the standard process or an unused
capability sitting on the shelf.
