The Federal Reserve has hiked interest rates three times this year, prompting some fixed income investors to depart some of the largest bond ETFs. For example, the SPDR Barclays High Yield Bond ETF (NYSEArca: JNK) and the iShares iBoxx $ Investment Grade Corporate Bond ETF (NYSEArca: LQD) are among the top 10 ETFs in terms of year-to-date outflows.
The Federal Reserve’s rising interest rates have been a main contributing factor in the downfall of investment-grade bonds this year. As the Fed hikes the short-term fed funds rate, longer-duration investment-grade bonds with historically low yields have appeared less attractive.
Still, some data points suggest that with tax-loss harvesting season afoot, embracing fixed income ETFs could be a solid strategy.
“With interest rates rising and bond prices falling, we conducted research this summer to determine the extent of fixed income losses and identify potential opportunities for tax loss harvesting,” said State Street Global Advisors (SSgA) in a recent note. “The results were compelling—our analysis of the 30 largest fixed income ETFs by assets under management (AUM) found significant losses across the fixed income spectrum. But markets can shift and change rapidly, so we reran the numbers as of the end of September to see what had changed.”
Credit Concerns
Some fixed-income observers are also concerned about the amount of debt floating around. The volume of debt issued by investment-grade companies since the financial downturn could be problematic if the economic cycle sours. Corporate investment-grade bonds now make up $6 trillion, compared to $2 trillion before the financial crisis. While some of the new issues is a result of economic growth, corporate leverage remains much higher than it was in the last cycle, which leaves them open to greater credit risk in case of a sudden reversal.
“Tax loss harvesting is the practice of selling an investment that has lost value to offset capital gains,” said SSgA. “If capital losses exceed a portfolio’s gains—or if there are no capital gains—the net loss can be used to offset up to $3,000 of the current year’s ordinary taxable income (even though the investor’s ordinary income may be taxed at a higher rate than capital gains). If the annual net loss is more than $3,000, the excess can be carried over to offset gains and ordinary income in future years.”