(Bloomberg) — The celebrity with tax efficiency The ETF market is poised to add a new string to its bow, with the arrival of two funds that offer a new way for investors to cut what they owe on capital gains.
The Cambria Tax Aware ETF (marked TAX) and the Stance Sustainable Beta ETF (STSB) will each be seeded with the appreciated securities of wealthy investors who will exchange their assets for shares in the funds instead of they buy them with money. This is a way of disposing of the property without actually selling it, which would make a taxable profit.
The approach is a new iteration of a growing trend in the $10 trillion U.S. ETF market, where money managers are converting existing products like mutual funds and separately managed accounts into wrappers 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 money invested for longer until then.
Unlike those conversions — which have involved firms bringing existing products under their management — the Cambria fund is directly inviting individual investors to bring in appreciated stocks from wherever they're held.
“You're going to contribute your portfolio from Schwab, Fidelity, wherever,” said Meb Faber, co-founder and chief investment officer of Cambria Investment Management, the quantitative firm that advises TAX. “Let's say you got $1 million in all these stocks, and then the next day you have the TAX ETF — and that's not a taxable event.”
The products resemble so-called “exchange-traded funds” or “exchange-traded funds”, which also combine investors' holdings in exchange for shares in a pooled portfolio. They have traditionally been arranged by banks for the super-rich, but have become more common as the now 15-year stock rally created a new class of millionaires, particularly in the technology sector.
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“It's democratizing the idea of an exchange-traded fund for the masses,” said Wes Gray, strategic advisor to ETF Architect, which provides the infrastructure for both TAX and STSB. “We will make it transparent, low-cost, efficient. Not an obscure structured high-priced product only for rich people.”
However, these new funds are likely to only make sense for those with fairly large capital gains. Gray thinks a typical beneficiary will have at least $500,000 in securities.
Meanwhile, unlike exchange-traded funds, ETFs can't receive contributions that are highly concentrated in just a small number of stocks. They will also be more liquid from the start and can be more easily diversified into stocks that have nothing to do with initial contributions.
The TAX ETF, expected to launch in December, will run a strategy that favors value and quality stocks with low or no dividend yields to avoid taxation on these payments. Faber says the fund will likely connect with Cambria's longtime clients, including financial advisers and family offices.
STSB, from sustainability-focused manager Stance Capital, is set to launch next month. Instead of marketing directly to individuals, it will seed from clients referred by wealth managers and broker-dealers.
Ultimately, as with most capital gains tax strategies on Wall Street, both funds will be about tax deferral, rather than elimination. Investors still retain ownership of one asset—the ETF shares—and if the time comes to liquidate their portfolio, they'll owe taxes on any gains.
“One of our screens at Stance Capital is we sound out companies that don't pay taxes,” said Bill Davis, founder of the money manager. “I don't think that diversification and essentially removing the tax can be inconsistent with responsible investment. I think total tax avoidance – 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 different portfolios as more investors sign up, according to Faber. He believes that no investor should pay more taxes than they should.
“I just think it makes more sense to push them if you can, like rich people have done for a hundred years,” he said. “The big difference here is that it's now available to everyone, not just billionaires.”