Key Takeaways
- 2020 was hailed as the “perfect year for tax-loss harvesting”, however, the first three quarters of 2022 have already delivered greater tax savings than all of 2020, with models on our platform experiencing a tax savings benefit of 2.99% from Q1-Q3.
- 2020 had one sharp decline lasting just over a month, but the overall trajectory for the year showed a steady increase. The year 2022 has delivered several market drawdowns with an overall negative trajectory through the first three quarters of the year.
- With interest rates continuing to rise, it has created an increase in yields, however, with a rise in yields comes negative returns. The negative returns we’ve experienced unfortunately have contributed to the losses seen in 2022, in addition to the damaged equity markets.
On January 5th, only two days after the market opened, we entered into negative territory on the year, and we haven’t looked back. We have been officially in a bear market since June 13th, when markets reached a 20% decline. October 1 marked 272 days since that day on January 5th. So what have we learned, and where have we helped?
Unlike the market drawdown seen in 2020, during the sharp pandemic decline, which lasted only about one month from 2/20/20 to 3/23/20, the market drawdown seen in 2022 has been steady. In addition, the trend line evident in 2020 presented us with an overall upward trajectory in the market from Q1 to Q3. However, this year has seen quite the opposite results, with the sentiment of the S&P500 as overall negative.
2020 vs. 2022 Market Drawdown
Although, many claimed 2020 to be the perfect year for tax-loss harvesting1, as we’ve observed over the past three quarters of 2022, 55ip has already delivered greater tax savings in 2022 than we did in the entire calendar year of 2020.
2022 So Far…
I’ve written about this in a prior post at the end of Q2 called Turmoil, Taxes, and Time. However, lets reflect on the year we’ve had so far, and take a closer look at recent events and how they have impacted the equity markets.
We started off 2022 with the ongoing sting of the coronavirus, Omicron. This was followed with the geopolitical threat from Russia’s invasion of the Ukraine. The impact of this war on Ukraine has been devastating. This led to world leaders to enforce bans and restrictions. These sanctions resulted in rising oil prices due to many nations refusing to purchase oil from Russia contributing to an increase in cost of goods. The flow of goods has also been impeded. Many materials such as steel, semi-conductors, and wheat have seen a rise in prices due to Russia’s exports of these prominent goods being restricted. Lastly, with one of the largest ports in the world being avoided, the world has also seen significant delays in transportation to the already crippled supply chain from 2020. The last time BlackRock’s Geopolitical Risk Indicator exceeded a score of 1, prior to Russia’s invasion of Ukraine, was back in July 2017 when North Korea tested Intercontinental Missiles2.
Global Geopolitical Indicator
What is being felt in the US through our financial markets has also been felt around the world, with global equities falling alongside US equities. This can be seen in the recent sharp selloff in September to that of March 2020. Although US-, Developed-, and Emerging-markets have shared a similar down trend month to month, the day-to-day global equity markets have been less synchronized across regions
The traditional hedge may not be dead, but is in critical condition
Beyond international markets, traditional hedges to the equity markets through fixed income has dramatically dampened performance in 2022. Unlike 2020, this year has seen a synchronous fall in the equities and fixed income markets. What has traditionally had an inverse relationship, stocks and bonds acting as a hedge, was the reason we often built 60/40 model strategies and relied on the concept that was the foundation for the Modern Portfolio Theory.
However, when you look at a year like 2020, the first few months of the calendar year when the markets were dramatically falling due to the pandemic outbreak, investors were able to find safe harbor from losses in fixed income assets classes such as US, Global, or High Yield bonds which all performed better than equities in March 20203.
Monthly Asset Class Performance
Those same asset classes this year have all seen better days, with US Fixed Income as the best performing asset class in 2022 YTD at -14.61%, followed by High Yield bonds as the second-best performing asset class of 2022 at -14.74% YTD. Let’s unpack why some of 55ip’s harvesting opportunities came from fixed income loss harvesting trades.
Fixed Income’s Contribution to Harvested Losses
Prior to Fed Funds rates rising to 3% from nearly 0%, we knew walking into 2022 we were expecting to see six to seven rate hikes in 2022. So it’s safe to say that the rate hike in September was in line with expectations, while the most recent hike on November 2nd pushed us to the highest we’ve seen since 2008. However, inflation demands have most definitely contributed to the Fed keeping in line with the expectations in rising rates, rather than correcting course through 2022.
Inflation demands stemmed from the labor shortages we’ve seen recently as well as supply chain issues from post-Covid constraints and the Russia / Ukraine war. With interest rates continuing to rise it has created an increase in yields, however, with a rise in yields comes negative returns. Along with rising yields in the short term, bond durations that would typically dictate rates of returns in a positive yield curve have now begun to flatten. This flattening of the yield curve will result in longer duration fixed income assets producing yields similar to lower duration bonds. The negative returns we’ve experienced unfortunately have contributed to the losses we’ve seen in 2022, in addition to the damaged equity markets.
Our results: 55ip is a painkiller, not a vitamin
Tax Savings is not a new term to the overall industry as most firms utilize tax alpha. However, 55ip’s value is not compared to a portfolio’s benchmark, rather it’s compared to the client’s exact portfolio if they hadn’t received tax-loss harvesting. The difference between the two models would be considered alpha – however, to humanize the savings we compare the estimated tax bill for the client vs what it would have been if they client received no tax harvesting. Although smaller in terms of results from an alpha number, provides significantly larger meaning to the advisor & client.
For the third quarter of 2022, 55ip’s estimated tax savings figure across clients was an astonishing 1.15%. This figure comes in higher than 8 of our last 10 quarters. Year to date, we provided 2.99% in estimated tax savings to our clients, a figure through nine months that is higher than our 2020 Year End tax savings figure 2.58%. When including the results from 2022 through Q3 with our overall results dating back to Q1 2020, 55ip has produced an Annualized Tax Savings of 2.82%.
If you’re intrigued by these numbers, contact 55ip to learn how we can support your efforts to make a down year more palatable with tax-loss harvesting.
Footnotes
1 http://wsj.com/articles/why-2020-was-the-perfect-year-for-tax-loss-harvesting-11604782408
2 http://blackrock.com/corporate/insights/blackrock-investment-institute/interactive-charts/geopolitical-risk-dashboard
3 Callan LLC July 2022
Results reported here are not related to investment performance. The impact of a tax-loss harvesting strategy depends upon a variety of conditions, including the actual gains and losses incurred on holdings and future tax rates.
The tax-loss harvesting service is available for an additional advisory fee and the results shown represent the net effect of the advisory fees but may not consider the impact of fees charged by others, including transaction costs or other brokerage fees. The information contained herein is subject to change without notice, is not complete and does not contain certain material information about the investment strategy, including additional important disclosures and risk factors associated with such investment and information about fees, trading costs and taxes. Neither the U.S. Securities and Exchange Commission nor any state securities administrator has approved or disapproved, passed on, or endorsed, the merits of this document. More information at www.55-ip.com.
2.99% reflects the estimated average tax savings for accounts which received a Tax Savings report from Q12022 through Q32022 using 55ip’s tax-smart technology. 2.82% reflects the estimated annualized average tax savings for accounts which received a Tax Savings Report for period from Q12020 through current quarter using 55ip’s tax-smart technology. The estimated annualized average tax savings is based on an arithmetic average of each quarterly tax savings. The quarterly tax savings of all accounts in a respective quarter are summed and divided by the number of years represented. The aggregated percent tax savings for each quarter is taken as an average and annualized to determine the estimated annualized average tax savings referenced above.
Calculation methodology: Average tax savings are calculated by comparing the client’s actual account activity with a shadow account created by 55ip. The shadow account has the same inception date and is invested in the same model as the client’s actual account but does not incorporate 55ip’s tax-smart technology for rebalancing. Gains and losses are accrued for both the client’s actual account and shadow account to produce the estimated tax bill. The tax rate applied to the client’s actual account and the shadow account are provided by the client’s advisor. If no tax rate is provided, then the highest applicable federal tax rate (20% for long-term gains/losses and 37% for short-term gains/losses) is assumed and an additional 3.8% net investment income tax rate is applied to both accounts. The estimated tax bill of the client’s actual account is then compared to the estimated tax bill of the shadow account, and the shortage of the former amount is the client’s estimated tax savings. There is no guarantee that the estimated tax and subsequent projected tax savings will equal the actual tax liability/tax savings achieved by the client. J.P. Morgan and its affiliates and employees do not provide tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any financial transactions.