ETFs provide exposure to various asset classes with similar risk profiles. This creates an opportunity for tax-loss harvesting.
For example, an owner of iShares S&P/TSX 60 (XIU) with an unrealized capital loss could sell and immediately buy iShares S&P/TSX Capped Composite (XIC), harvesting a valuable tax credit while staying invested in Canadian equities.
While the two ETFs are similar in terms of performance (save a “Nortel effect” where one stock outperforms the rest of the index, when the capped XIC would perform very differently), they track separate indices.
To avoid swapping ETFs based on the same underlying index, an advisor could use a risk model to identify “risk twins,” or ETFs that could be used interchangeably. Another example is BMO S&P/TSX Equal Weight Oil & Gas Index (ZEO) and iShares S&P/TSX Capped Energy Index (XEG).
More risk twins can be found in the table below, “Examples of risk twins for tax-loss harvesting.”
|iShares S&P/TSX 60 Index Fund (XIU)||iShares S&P/TSX Capped Composite Index Fund (XIC)|
|iShares S&P/TSX Capped Composite Index Fund (XIC)||Horizons BetaPro S&P/TSX 60 Index ETF (HXT)|
|Horizons BetaPro S&P/TSX 60 Index ETF (HXT)||iShares S&P/TSX 60 Index Fund (XIU)|
|Horizons BetaPro S&P/TSX 60 Index ETF (HXT)||Claymore Canadian Fundamental Index ETF (CRQ)|
|iShares S&P/TSX Capped Energy Index Fund (XEG)||BMO S&P/TSX Equal Weight Oil & Gas Index ETF (ZEO)|
|iShares S&P/TSX Capped Financials Index Fund (XFN)||BMO S&P/TSX Equal Weight Banks Index ETF (ZEB)|
|iShares S&P 500 Index Fund (CAD-Hedged) (XSP)||BMO US Equity Hedged to CAD Index ETF (ZUE)|
|Claymore Broad Emerging Markets ETF (CWO)||iShares MSCI Emerging Markets Index Fund (XEM)|
|iShares MSCI Emerging Markets Index Fund (XEM)||Claymore BRIC ETF (common class) (CBQ)|
|iShares DEX Universe Bond Index Fund (XBB)||Claymore Advantaged Canadian Bond ETF (CAB)|
|Claymore Gold Bullion ETF (CGL)||Horizons BetaPro COMEX Gold ETF (HUG)|
In any core/satellite portfolio, a passive core could generate tax losses to offset realized capital gains from active satellite strategies.
ETFs offer after-tax opportunities in addition to their inherent tax efficiencies. Some synthetic ETFs (an ETF that uses derivatives) offer investors and their advisors effective ways to manage tax but also introduce new risks. Carefully managed, ETFs offer ways to create tax flexibility that can make investors’ accountants smile.
Ioulia Tretiakova is Vice President and Director of Quantitative Strategies at PUR Investing Inc., a software development firm specializing in disruptive strategies for investors, their advisors and pension plans. PUR is a registered portfolio manager. www.purinvesting.com