A pair of new bond exchange-traded funds is making it easier than ever for investors to avoid taxes on coupon payments.
The F/m Compoundr High Yield Bond ETF (CPHY) and the F/m Compoundr U.S. Aggregate Bond ETF (CPAG) began trading this week with the goal of transforming “interest income into unrealized capital gains,” according to F/m Investments’ website. To do so, the ETFs will sell off holdings prior to their dividend dates to avoid receiving a taxable distribution.
The two funds join a growing list of ETFs designed to further minimize investors’ tax bills. The ETF wrapper — famed for deflecting capital gains taxes by using a mechanism known as in-kind redemptions — is still subject to taxes on ordinary income, such as dividend or coupon payments. However, rotating out of holdings just before their ex-dividend date allows an ETF to sidestep the taxable event.
CPHY and CPAG employ the process for fixed-income ETFs, while Roundhill Investments launched the S&P 500 No Dividend Target ETF (XDIV) last month.
“We talk to our investors all the time, and we found that many of them like the yield we produce, they just hate the distribution,” said Alex Morris, CEO of F/m Investments. “The idea of let’s just get rid of the dividend to provide total return — legitimate, frictionless total return in bonds — was what we wanted to do.”
CPHY and CPAG charge an annual expense ratio of 0.59% and 0.45%, respectively. The pair is the first in a planned series of fixed-income ETFs from F/m and Compoundr that aim to help investors sidestep taxes.
The strategy, typically reserved for private wealth clients and high net-worth investors, is now being utilized by ETF issuers largely thanks to the $12.2 trillion industry’s rapid growth.
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Both CPHY and CPAG invest in other bond ETFs, which they exit ahead of an ex-dividend date and temporarily rotate into similar ETFs that aren’t about to pay a distribution.
“It was never really packaged up in a way that could be accessed by everyone, it was always this personal experience, and mileage was going to vary,” Morris said. “ETFs are mature enough that you can do this. You couldn’t do this 10 years ago.”
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Issuers are increasingly launching equity and fixed-income products designed to maximize after-tax returns, according to industry veteran Dave Nadig.
“It’s very simple, there’s not a lot of complexity to it, it’s very clever,” said Nadig. “I would expect to see this type of strategy roll through every other asset class.”
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