A stronger than expected jobs report and the Institute of Supply Management (ISM) Non-Manufacturing Index report for August have markets now positioning for the likelihood of another 0.75% interest rate increase at the central bank’s next meeting at the end of September. With inflation persisting at a flat month-over-month rate in July, equities have continued to be hit hard, providing the possibility of tax-loss harvest and moving to an alternative fund type that might be better suited to mitigate some volatility within equities while seeking to provide income opportunities.
As long as inflation persists at high levels, it can continue to erode the buying power of consumers, impacting a broad range of equities and having far-reaching effects across supply chains and more as higher costs eat into margins. The Federal Reserve has committed to fighting inflation at all costs, a message most recently reinforced by Federal Reserve vice chair Lael Brainard.
“Monetary policy will need to be restrictive for some time to provide confidence that inflation is moving down to target. The economic environment is highly uncertain, and the path of policy will be data dependent,” Brainard cautioned in a recent speech.
Soaring, persistent inflation has already taken a toll on equities this year, particularly growth-oriented ones that have seen their forward fall precipitously from decade-long highs. The S&P 500, an index comprised of around 500 of the top U.S.-listed companies that make up about 80% of the U.S. equity market cap, is down just over 17% year-to-date as of September 7, 2022.
Tax-Loss Harvesting Opportunities
“With an ongoing bear market, many advisors hold positions that have incurred losses in 2022. They can use the liquidity and tax efficiency benefits of ETFs to improve their client portfolios while staying diversified,” explained Todd Rosenbluth, head of research at VettaFi.
Losses within equities this year could be captured via tax-loss harvesting, a practice whereby the investment is sold off at a loss, and those losses can then be applied to taxes owed on investments making a profit. In other words, capital losses can offset capital gains, though tax-loss harvesting is a tax deferral, not a cancellation.
Advisors and investors selling an investment for tax-loss harvesting purposes but still wishing to maintain their exposure need to be aware of the wash-sale rule, which prevents repurchasing of the identical security or investment sold for 60 days around the sale (30 days before and 30 days after) or else the capital loss will not be applicable towards offsetting capital gains. The way around this is to purchase a like fund that still provides the desired exposure but is different enough not to trigger the wash-sale rule.
In the case of the S&P 500, if an investor had an allocation to a broad-based ETF that covered the S&P 500 and they wished to capture those capital losses to offset any gains they might have this year, they could sell the broad-based ETF at a loss and move into a fund that offered potentially better positioning within the S&P 500 for the current market of uncertainty while also providing monthly income opportunities.
Various ETFs are available that work to help mitigate volatility within equities or seek high current income, but few funds combine the two using a collar strategy. A collar strategy entails holding shares of underlying security while simultaneously buying protective put options and writing calls for the same security and seeks to reduce volatility, generate income, and provide a measure of downside protection.
A put option gives its owner the right but not the obligation to sell the underlying asset at a specific price on a specific day. In contrast, a call option gives its owner the right but not the obligation to buy the asset instead.
Nationwide offers a variety of actively managed ETFs that utilize a collar strategy within equities, including the Nationwide S&P 500® Risk-Managed ETF (NSPI), an ETF that invests in a portfolio of securities included in the S&P 500 Index, and a fund that could be used to tax-loss harvest into this year.
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The price to earnings (P/E ratio) is calculated by dividing the stock’s current price by its latest earnings per share
This article was prepared as part of Nationwide’s paid sponsorship of VettaFi.
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KEY RISKS: The Nationwide Nasdaq-100® Risk-Managed Income ETF, Nationwide S&P 500® Risk-Managed Income ETF, Nationwide Dow Jones® Risk-Managed Income ETF, and Nationwide Russell 2000® Risk-Managed Income ETF (collectively, the “Risk-Managed Income ETFs”) are subject to the risks of investing in equity securities, including tracking stock (a class of common stock that “tracks” the performance of a unit or division within a larger company). A tracking stock’s value may decline even if the larger company’s stock increases in value. The Risk-Managed Income ETFs are subject to the risks of investing in foreign securities (currency fluctuations, political risks, differences in accounting and limited availability of information, all of which are magnified in emerging markets).
The Risk-Managed Income ETFs may invest in more-aggressive investments such as derivatives (which create investment leverage and illiquidity and are highly volatile). The Risk-Managed Income ETFs employ a collared options strategy (using call and put options is speculative and can lead to losses because of adverse movements in the price or value of the reference asset). The success of the Risk-Managed Income ETFs’ investment strategy may depend on the effectiveness of the subadviser’s quantitative tools for screening securities and on data provided by third parties. The Risk-Managed Income ETFs expect to invest a portion of their assets to replicate the holdings of an index. Correlation between Fund performance and index performance may be affected by Fund expenses and because the Fund may not be invested fully in the securities of the index or may hold securities not included in the index.
The Risk-Managed Income ETFs frequently may buy and sell portfolio securities and other assets to rebalance its exposure to various market sectors. Higher portfolio turnover may result in higher levels of transaction costs paid by the Risk-Managed Income ETFs and greater tax liabilities for shareholders. The Risk-Managed Income ETFs may concentrate on specific sectors or industries, subjecting them to greater volatility than that of other ETFs. The Risk-Managed Income ETFs may hold large positions in a small number of securities, and an increase or decrease in the value of such securities may have a disproportionate impact on the Funds’ value and total return. Although the Risk-Managed Income ETFs intend to invest in a variety of securities and instruments, the Risk-Managed Income ETFs will be considered non-diversified.
Additional risks include: Collared options strategy risk, correlation risk, derivatives risk, foreign investment risk, and industry concentration risk.
The Fund expects to invest a portion of its assets to replicate the holdings of an index. Correlation between Fund performance and index performance may be affected by Fund expenses and because the Fund may not be invested fully in the securities of the index or may hold securities not included in the index. The Fund frequently may buy and sell portfolio securities and other assets to rebalance its exposure to various market sectors. Higher portfolio turnover may result in higher levels of transaction costs paid by the Fund and greater tax liabilities for shareholders. The Fund may concentrate on specific sectors or industries, subjecting it to greater volatility than that of other ETFs. The Fund may hold large positions in a small number of securities, and an increase or decrease in the value of such securities may have a disproportionate impact on the Fund’s value and total return. Although the Fund intends to invest in a variety of securities and instruments, the Fund will be considered nondiversified. Additional Fund risk includes: Collared options strategy risk, correlation risk, derivatives risk, foreign investment risk, and industry concentration risk.
S&P 500® Index: An unmanaged, market capitalization-weighted index of 500 stocks of leading large-cap U.S. companies in leading industries; gives a broad look at the U.S. equities market and those companies’ stock price performance.
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