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The advantages of tax-loss harvesting in index replication are becoming more and more clear. The benefits are small but both significant and consistent and would make a fund that has returns larger than standard index funds (which would likely put it in the top 10% of all funds consistently). As shown by the Weathfront 500 technology behind the process is not particularly hard. There is clearly some advantage to being the first mover in this kind of space (see Vanguard). As a kicker people clearly hate taxes with a passion.

So why isn't there a liquid tax-loss harvesting fund/ETF easily available to buy? The only one I can find involves buying into a whole portfolio other things and paying extra management fees.

  • Am I wrong in thinking that this would only be of benefit to those investors holding such a fund or ETF in a taxable account? – Beanluc Mar 21 '18 at 22:46
  • You are correct. These funds would be on average worse than a standard index fund (though arguably still better than most active mutual funds) in a tax-advantaged account like an IRA or 401k. – rhaskett Mar 21 '18 at 22:52
  • That may be a big reason why nobody has composed and marketed such a fund. – Beanluc Mar 21 '18 at 23:37
  • No judgement but web sites like that always pitch a good game but do they provide performance stats of their various "replications" ? Or are we to take their good word for it? – Bob Baerker Mar 21 '18 at 23:52
  • @BobBaerker Always fair and as the Arnott paper (linked above) shows we should be very wary of claims of out performance. However, it is fairly easy to check if the promised tax losses are achieved and tracking error to the index in reasonable. These harvesting strategies are available through a number of companies/banks and appear to be widely used by family offices serving high net worth individuals, but why not for the general masses? Legal issues? – rhaskett Mar 22 '18 at 0:06
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It turns out the reasons are technical. ETFs and Mutual Funds can't pass through their tax losses so the harvested losses can't benefit the investors when it comes to tax time.

Wealthfront and family offices serving high net worth investors use Separately Managed Accounts which allow the losses to pass through to the investors. These specialized accounts require a good chunk of capital to make it worth the effort for the institution.

  • While it's a good point that the typical structure of a Mutual Fund or ETF can't pass the loss back, the "fund" could just be structured as a partnership. There are plenty of publicly traded partnerships. Though, even then, you run in to structural issues of decision making and costs well in excess of a "low cost" index MF or ETF. – quid Mar 22 '18 at 17:24
  • Interesting, I don't know much about PTPs. From what I read they can definitely pass on the losses but it seems like there would limited by law to qualified investors. – rhaskett Mar 22 '18 at 18:43
  • IIRC, qualified investor rules are about specific fundraising, I'm not sure they'd apply to a person buying 0.0004% of a company via public exchange. As a couple random public partnership examples, NBLX (and many energy companies), some asset managers like CG, some funds like USO; and all will issue K1 tax forms which transfer losses and gains. Though, a fund like the one being described in the question may have some SEC regs about what it's allowed to call itself and what it's allowed to advertise. "Tax Harvesting Index Fund" would probably be off the table... – quid Mar 22 '18 at 18:50
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Because that wouldn't be an index fund. An index fund manager makes zero decisions. The index has a formula, the fund follows the formula. Tax loss harvesting would involve decision making and substitute holdings, that's an actively managed fund; even if it purports to attempt to track some index but with the added benefit of tax loss harvesting.

  • Your strict classification is correct. While tax loss harvesting funds wouldn't technically be an index fund, designers of these funds can generally harvest while still keeping tracking errors to the index below 2%. I modified my wording in the original question. – rhaskett Mar 21 '18 at 22:16

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