8 November 2023

There's More to Tax-Loss Harvesting Than You Think

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There are more moving parts to tax-loss harvesting than just identifying the tax benefit of selling bonds at a loss. Investors shouldn’t ignore potentially sizable transaction costs and the possibility that replacement opportunities may be scarce. These factors also play key roles in determining if a tax-loss harvesting transaction makes sense.

Across AB’s suite of municipal bond solutions, we only make a transaction in a tax-loss opportunity if the benefit outweighs the costs after considering all relevant factors:

  1. Tax Benefit: This is calculated at the tax-lot level, so each bond at a loss is scrutinized using the client’s respective tax rate. The higher the tax benefit, the more attractive it is to sell a security.
  2. Transaction Cost: Position size, credit rating and duration come into play when determining the cost to sell a given bond. Volatile markets tend to reduce liquidity, which can make it more costly to sell—especially a smaller position. A higher transaction cost makes the security less attractive to sell.
  3. Replacement Opportunities: Two aspects are key: how quickly cash can be re-deployed into the market and whether there are attractive buying opportunities that increase expected returns. A low expected cash drag, and a higher expected excess return make selling more attractive. 


How AB Evaluates Tax Opportunities: An Example

We compare two opportunities in the Display below. Bond A has a tax benefit of 166 basis points (bps), costs 90 bps to trade and increases excess expected return by 40 bps. The benefit is 206 bps: 166 bps tax benefit plus 40 bps increase in expected return. Subtracting the 90 bps transaction cost would leave the client with a net benefit of 116 bps. The same analysis on Bond B illustrates that the cost to trade completely offsets the benefit of the tax-loss transaction, so we would not choose that tax-loss harvesting opportunity.

Key Point: Bond B has a greater percentage loss, but Bond A brings a higher net benefit to the client. 

Even if selling Bond B produced a net benefit of 10 bps to 20 bps of positive net benefit, we generally wouldn’t view it as an attractive trade, because the net benefit to the end client isn’t big enough. We typically aim to generate at least 100 bps of net benefit before engaging in a transaction. It’s clear from this example that while locking in losses may seem like a sure thing, the size of the loss is just one piece of the puzzle. 

A Holistic, Data Driven Approach to Tax Management at Scale

For illustrative purposes only. There can be no assurance that any investment objectives will be achieved.
ST: Short-Term, which applies a tax rate of 40.8%
LT: Long-Term, which applies a tax rate of 23.8%
Source: AB

It might seem complex to weigh all these factors when considering tax-loss harvesting opportunities. That’s why AB has leveraged technology to create an active tax-loss harvesting program that enables a consistent, systematic approach to year-round tax management. 

This approach can help clients avoid being compelled to realize losses during potentially illiquid and volatile markets. What’s more, we recalibrate our hurdle rates for tax-loss harvesting as yield levels rise and fall (Display).

AB Actively Recalibrates Hurdle Rates for Tax Loss Harvesting As Yields Rise or Fall

The information provided is for informational purposes only.
Data represented above is derived from both external providers and AB internal systems. 
As of October 31, 2023
Source: Municipal Market Data and AB

What Makes AB’s Municipal Bond Solutions Different 

An active, tech-driven approach is a key differentiator of AB’s municipal bond separately managed account solutions. It helps us uncover market opportunities in real time, using year-round tax-loss harvesting to transform investments that have lost money into tax winners. 

Learn more about AB’s Municipal Bond strategies.

There is no assurance that a separately managed account will achieve its investment objective. Separately managed accounts are subject to market risk. The market values of securities owned will fluctuate so that your investment, when redeemed, may be worth more or less than its original cost.

The information contained herein are from sources believed by AllianceBernstein L.P. (“AB”) to be reliable. No representation or warranty is made concerning the accuracy of any data compiled herein. AB does not provide tax, legal or accounting advice. In considering this material, please discuss your individual circumstances with professionals in those areas before making any decisions.

The [A/B] logo is a registered service mark of AllianceBernstein and AllianceBernstein® is a registered service mark used by permission of the owner, AllianceBernstein L.P. 

© 2023 AllianceBernstein L.P.

 

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