(Bloomberg) -- The famously tax-efficient ETF market is about to add a new string to its bow, with the arrival of two funds offering a fresh way for investors to cut what they owe on capital gains.
The Cambria Tax Aware ETF (ticker TAX) and the Stance Sustainable Beta ETF (STSB) will each be seeded with the appreciated securities of wealthy investors, who will swap their assets for shares in the funds rather than buy into them with cash. That’s a way of disposing of holdings without actually selling, which would realize a taxable gain.
The approach is a fresh iteration of a growing trend in the $10 trillion US ETF market, where money managers are converting existing products like mutual funds and separately managed accounts into the wrapper to benefit from its tax advantages. ETFs themselves rarely realize capital gains. Instead, investors only bear the burden when they exit the fund altogether and can keep more cash invested for longer until then.
Unlike those conversions — which have involved firms flipping existing products under their management — the Cambria fund is directly inviting individual investors to bring appreciated stocks from wherever they are held.
“You’ll contribute your portfolio from Schwab, Fidelity, wherever it is,” said Meb Faber, co-founder and chief investment officer of Cambria Investment Management, the quant firm advising TAX. “Let’s say you’ve got $1 million in all these stocks, and then the next day you’ll have TAX ETF — and it’s not a taxable event.”
The products resemble so-called “swap funds” or “exchange funds,” which also combine the holdings of investors in return for shares in a pooled portfolio. Those have traditionally been arranged by banks for the super rich, but have become more common after the now 15-year-long stock rally minted a new class of millionaires, especially in the tech sector.
Read more: Tech Millionaires Chase Billionaire Tax Shields With ‘Swap Fund’
“It’s democratizing the idea of the exchange fund for the masses,” said Wes Gray, strategic advisor to ETF Architect, which provides the infrastructure for both TAX and STSB. “We’re going to do it transparent, low-cost, efficient. Not an opaque, overpriced structured product only for rich people.”
All the same, these new funds will likely only make sense for those with sufficiently large capital gains. Gray reckons a typical beneficiary will have at least $500,000 in securities.
Meanwhile, unlike swap funds, the ETFs cannot take contributions that are too concentrated in just a handful of stocks. They’ll also be more liquid from the start, and could more easily diversify into shares that have nothing to do with the initial contributions.
The TAX ETF, expected to launch in December, will run a strategy that favors value and quality shares with low or no dividend yields to avoid being taxed on those payouts. Faber says the fund is likely to be seeded with Cambria’s long-time clients including financial advisers and family offices.
STSB, from the sustainability-focused manager Stance Capital, is poised to launch next month. Rather than market directly to individuals, it will be seeded by clients referred from the likes of wealth managers and broker-dealers.
Ultimately, as with most capital gains tax strategies on Wall Street, both funds will be about deferring taxes, rather than eliminating them. Investors still retain ownership of an asset — the shares of the ETF — and if the time comes to liquidate their portfolio, they’ll owe tax on any gains.
“One of our screens at Stance Capital is we ding companies that don’t pay taxes,” said Bill Davis, the money manager’s founder. “I don’t think diversifying and basically kicking the tax can down the road is antithetical to responsible investing whatsoever. I think avoiding taxes entirely — you could argue that it is, but that’s not what we’re doing.”
If it goes well, Cambria hopes to launch other similar ETFs made up of various portfolios as more investors sign up, according to Faber. He reckons no investor should be paying more taxes than they need to.
“I just think it makes more sense to defer them if you can, the same way rich people have for a hundred years,” he said. “The big difference here is it’s now available to everyone, not just the billionaires.”
