At the Money: Deferring Capital Gains on Appreciated Equity
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Enterprises are busy embracing the technologies that underpin industry four point of such as A I and automation. But now the fifth industrial revolution is coming. So what is IT? What could I mean for our jobs? I'm had a fry. You can learn more .

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Let me tell you how I will be. This one for you, ninety for me.

Some investors have big concentrated equity positions that have a rude big gains. Maybe it's due to employee stock option plans, perhaps they have some founder stock from a startup, maybe there was an IPO or takeover, but suddenly they find themselves sitting on an uncomfortable ly large percentage of their portfolio in a single name.

The chAllenge for investors is how can they diversify when selling shares leads to owing big capital gains? What's an investor to do? I'm barrier ritts.

And on today's edition of at the money, we're going to discuss how to manage concentrated equity positions with an eye towards diversification and managing big capital gain taxes to help us on pack all of this and what that means for your portfolio. Let's bring a map. faber.

He is the founder and chief investment officer of canberra. The fund ruins fifteen tf sand managers, nearly three billion dollars in assets. Their new etf is coming out in december twenty twenty four.

The canberra tax aware etf symbol tax is a solution to address just these chAllenges of concentrate positions. So mab, let's just start with a basic question. Tell us what a concentrated position is well .

to ramping stoping bull market. I know most investors don't feel like IT, but uh, a lot of people have had stocks go up a lot. A listeners think to two thousand nine, the bottom at the bottom um stocks have almost been a ten beggar and that's the broad market.

So individual stocks like in vidia or apple or others probably have gone up much more. And the way math works, you end up with the stock that goes up a bunch that gets me a bigger, bigger percentage of your portfolio. And that becomes a problem because there are no longer diversify.

But so many investors, the response to that is I can't sell IT because uncle sam is gonna kill me. The arrest is going to kill me warn buffy you know talks about this all the time on concentrated positions um and IT becomes a problem. You get lobster in your portfolio and then many investors .

simply feel stuck. So talk a little bit the historical first. You can pay for a color that sort of locks your stock Price in IT doesn't mean you're not gna pay capital gains tax.

I just tells you if this stock collapse is well, the expensive put you bought will cover IT, but you're still going to end up owing capital gain taxes or some people right covered calls as a way to offset some of a that risk. You still have the risk that the stock could drop um or you've the risk stock could get called away if IT runs up and you paying the gains. Um either way, none of these solutions are optimal. Tell a little bit about the thinking behind the tax where etf.

So if you go back almost one hundred years and talk to any real state investor, one of the ways they've built generational wealth is the famous ten thirty one exchange, where you buy building, you buy hotel and you're able to sell IT swap t for a new property. And that is not a taxable transaction. Amazing right now in stocks, there's been something not too decembers called the exchange fund.

Been around really since the one thousand nine seventies. Even vancsik on sax margin put out a lot of these. The problem with those, you've got to be a credit or qualified.

That means, rich, you've got to hold IT for seven years. And usually, they are just loaded with fees. They are set up fees. They're usually gona charge you a percent half a year and you end up with the portfolio of just whatever people contributed. So it's still problematic, not a great solution.

And so there is another acron m another term three fifty one, which has has been an attacked code for almost one hundred years, but really hasn't seen a lot of development until the last ten years and then increasingly so with the etf um and really this concept has been a lot of prior art. There's been over a hundred of these. Um first one may be about a decade ago, but you've really seen IT with mutual fund etf conversion, separate account T F conversions. And what we are announcing is an open and roman seeding of an etf with this three fifty one conversion.

So let's discuss how this works. I'm sitting on a broad of NVIDIA or microsoft or some other highly appreciated stock, and I want to get to versified rather than cell and pay the twenty three percent long term capital gain tacks. I could tend to these shares uh, to canberra and they will use IT in part of a broader y tf.

So i'm not selling IT. I'm getting diversification without paying the tax. Explain how that .

works yeah so you can also berries got ten million in video. You can't just check all this in video into the fun and see the etf. What happens is there's two main rules to qualify. The first is no position can be above twenty .

five percent of the portfolio of correct .

of your report folio. Second is anything that over five percent has to be less than fifty percent. So you could put in you in video, your apple, but really you probably got ta have a somewhat diverse fied portfolio.

Let's say you can do eleven stocks maybe now it's nice, is etf look through or pass through so you could contribute S P Y or another etf, the use one hundred percent of that because it's to look through into the underlying companies. But what so the concept that we've come to put together, ers, we're gonna ther up all these investors. So individuals, financial advisors, we have clients with highly appreciated stockpot foils, cover them all together, put them into the seed of to the new etf.

And after the etf launches, you then have that T F running is actually the first of three funds. And it's going to be sort of a consistent timeline of open and romance. The people want to contribute.

You have to contribute to get the tax benefits um when the fun launches uh and then you get a etf return and the benefit is attached to four. Its not a uh taxable transaction. From ceding the fund to getting the E T turn right.

So to clarify this, you are escaping the taxes. You're just not paying them until you sell that etf. So you're cost spaces. All those other things just get transfer the etf and on a dollar for dollar basis, is that is that accurate?

Yeah and and it's clear that the etf structure up and running. So even if you just go buy an etf is a vaio structure than a mutual marrow. This summer was saying that just the structure alone in a taxable count is probably a one percentage point advantage in an equity fund um because you're not paying consistent capital gains.

S P Y hasn't paid a capital gains since it's launched in the one thousand nine hundred ninety. And on average, the average T F won't be paying in the capital gains because of that in kind creation redemption mechanism. So this combines the best features of pay, seeding a fine tax efficiently and then running at tax efficiently as well.

So does that matter if i'm tendering to you um a large cap growth stock like a video or a small cap biotech or a midcap retailer, are you thinking about pulling together different types of funds, different types of sectors for this?

yeah. So the first fund is also a unique fund and it's A U. S. Dark fund.

And we did a paper about a decade ago, I don't think anyone read IT, but I was about tax optimization with the etf structure. Academic literature. There's actually not that much the targets tag top optimization that acknowledges the etf structure.

Most of IT just assumes you in a separate account. And so the etf structure allows you to do certain things. And so this fun will actually target U. S stocks that are value or quality stocks, but that do not pay high dividends.

And said differently, we want the dividend yield, this fund to be as close or at zero because if you're taxi ble investor in my hometown ate to california, your home state, chances are if you're taxable, you don't want four, six, eight, ten percent fifty yells. You have to pay those every year. So ideally, being able to differ the dividend, turn those in the capital gains and defer them is also a huge benefit.

So that's the first U. S. Stock fund. Second fund will be a diversey uh, etf portfolio. Third fund will be a global stock fund. And then four, five, six will be whatever barry request.

So when you say diversified T, F, instead of tending you, my in video, I can tender my cues. And what I get back in exchange will be a fund of etf and E T F 和 E T F。

Yeah so the cool part is this has been done. You know we we're partnering with the the good crude etf architect. It's a bunch of marines.

They have that military efficiency. The last one of these they did for announce manager have five thousand accounts. Wow, so incredible ability to heard cats put all this together.

And so yes, for the first fun, ideally it's it's ID large cap U S. Stocks, but you could do E, T, S, because they're passed through. So if you contribute S P Y, that's fine because he owns the underlying securities.

If you contribute the cues, I know you still got a bunch of game stop. Uh, you could contribute that right. But on the second fun, it'll be more of a global portfolio. You can contribute private assets, you can contribute your doge coin, you can contribute futures, options, things like that up, general stocks, E T S R A O K.

So let's talk a little bit about the management of the actual etf. When its us stocks, how do you figure out what of the tender stocks you want to keep and what you want to get rid of? It's not just going to be random what everybody happens to present to you, you're gonna ganim this around some key investing principles. I assume everything .

we do at canberra is systematic rules space. We like to call in house indexing. And so this fund will be a quarterly rebaLance, hundred stocks.

And again, it's targeting value quality companies that pay low to no dividend. And you're gna see a big sea change the next three to five years of asset managers. And r is optimizing taxable tax, uh, and the non taxable retirement accounts for various type of investments.

Look, they've always done this. We've always done this. But even to a higher extreme, we've done the math on some of these high field portfolio taxable accounts. And if you can invest in something like a high dividend field fund or read strategy, something with a lot of yield and a tax count, but not pay any yield, you can outperform and after tax basis, by multiple centage pots. In some cases, that is higher three.

And so with all this focus on expense ratio, with all this focus on that, that just headline, what is the cost of my fun? Most people ignore taxes, which can be ordered magnitude bigger than the decision to pay something like an expense, a show. So this fun targeting, no, the low yielding stocks. Maybe not the most marketable idea on the planet, uh, but something that one after tax spaces makes a lot of sense.

And so when someone tender either etf for stocks to you, they may or may not end up in the final etf. You have the ability to do uh, in kind exchange. So if you decide to sell IT and replace with something else, there are no taxes to either the person that contributed that or the etf. You're just swapping microsoft for amazon, whatever IT happens to be that also a tax free transaction. Is that right?

This is why so many neutral funds have converted to etf. So there was a hundred billion of conversions. Last year, the most famous probe, D.

F. A. They did about fifty billion of mutual fund conversions as mutual funds. If you have turn over, you're gonna have to pay out those capital gains.

And so every year, about the end of the year, you get these notices. Here's my expected capital gains in this mutual fund. And then you look over the etf landscape and you see across the board almost always zero. This is why we say, to borrow a phrase from mark and Jason, etf are eating the asset management industry is simply a Better structure so because of this creation redemption mechanism, these funds can be managed and run tax efficiently uh with no capital gaines uh distributions .

yeah our preference in the office um the four one case in four three bees, if they want to own mutual funds, they are welcome. But the taxable account, the preference anytime there's a choice, we always pick the etf over the mutual fund. Those fanum gains are pretty mazing.

So final question, one of the things i'm aware of is that a credit investors, wealthy investors, have been able to do this with separately manage accounts are where they are essentially exchanging highly appreciated stock for a broader diversified portfolio without incurring capital gain tax. How are they able to do that all these years? I know that this is not very uncommon, but it's taking .

place for quite a while.

Change fund n, which has really been around the ninety seventies, eating vance golden sax, maryland ch uh, have been doing this for their credited and qualified clients. You got one hundred million of tesla. You can submit to this fund.

You get one hundred of your bodies to summer their stocks. You end up a portfolio what everyone submitted. But the rules are you have to hold IT for seven years.

You end up with just whatever these people have contributed, usually reflects the S M P or the cues or something like that. But the biggest problem and across the board and there are massive fees, there's fees to set up. The fun there is usually the managment fees, a percent at half or two percent per year on average.

And then at the end of IT, you get distributed those stocks. So not the most ideal situation, maybe Better then sitting on a concentrate of portfolio. But the exchange fund has has been around for a long time for these are credit qualified investors, and we're trying to bring this to the masses and make IT hopeful ly available for anyone.

So last question is a fascinating idea. I know your over etf architect, west gray and others. How on earth did you guys come up with this?

So west works with the lawyer name bowood. We did a podcast with west and bob in february this year. They did a deep dive on three transactions because, like yourself, I I wasn't that deeply knowledgeable about this phrase.

I'd never really heard IT before, but IT turns out he did the first one a decade ago, and he's done about a hundred cents. I have chatted with folks NASA. They said there's been multiple hundreds of these, but usually it's a closed door.

Hey, I have a fund or I have a couple accounts here. It's going to be my client. Our innovation that I said to west, I said, west, why can't we do this? Why can't we open this up? Open a romance to everyone to contribute any says, I think we can end. But again, you need that military efficiency of all these marines etf architect to be able to together thousands of accounts and keep us available to everyone, uh, which should be the first many funds.

So to to wrap up, investors with concentrated equity positions that have appreciated a great deal should consider a form of diversification that doesn't force them into uncle sams arms that any form of three fifty one exchange. So perhaps the cambridge a attack where etf take your tax might be a solution to address the chAllenge of your concentrated position. I'm barry results and this is bloomberg s at the money.

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