The 351 Exchange ETF Is Here. More Are on the Way

Where did the capital gains go?

An ETF tax trick for wealthy investors has been snowballing this year. So-called 351 exchanges, which let investors transfer assets from other holdings in their portfolios and defer (or ultimately avoid) capital gains taxes, are popping up in an expanding menu of exchange-traded funds. The latest choice is from Cambria Investment Management and is the third such fund it has added to its line. The Cambria Global EW ETF (GEW) launched last Thursday and had attracted $150 million ahead of its debut. The company’s prior two 351 exchange ETFs, the Tax Aware ETF (TAX) and Endowment Style ETF (ENDW), garnered $30 million and $100 million leading up to their respective launches.

“My expectation for the next one is going to be many multiples of this current one,” Cambria founder and CIO Meb Faber said. Industrywide, “the end of this year and Q1 of next year will be the dam breaking on assets.”

Everywhere All at Once?

The 351 exchange strategy isn’t new, but it has taken off recently beyond the quietly debuted products RIAs and family offices tailored to their clients. The tactic hadn’t been advertised and only existed in recent years to give investors a convenient way to move assets without triggering capital gains taxes. This year, several ETFs have come out, and there is more attention, both among proponents and those concerned about a potential tax loophole. Sen. Ron Wyden, D-Ore., for example, introduced a bill designed to prohibit such asset transfers, though it faces slim odds in Congress.

“It seems that there is no limit on the investment strategies whose after-tax returns cannot be improved by undertaking them in an ETF,” Jeffrey Colon, law professor at Fordham University of Law, wrote of the ETFs used as swap funds, in a paper published over the summer. “[A]n ETF investor obtains an after-tax result that could not be obtained had the investor carried out the investment strategy directly. This is the essence of an inappropriate tax arbitrage.”

So far, there are at least four 351 exchange ETFs available, though they have required investment minimums for seeding, according to Morningstar Direct and company data:

• The $31 million TAX, $122 million ENDW and the new $150 million GEW, from Cambria.
• The biggest, the $476 million Alpha Architect US Equity ETF (AAUS), which launched in July.
• Cambria is planning another launch in December, the US Equal Weight ETF (USEW), and Alpha Architect, which partners with Cambria for that firm’s ETFs, is adding its second, also in December called the US Equity 2 ETF (AAEQ).

351 Ways to Leave Your Direct Indexer: The tax-deferring (or eliminating) strategy feels new to most, even many seasoned advisors, Faber said. The 351 exchanges are still in the early adopter phase, but he expects that to change, particularly as people look for “an offramp” from direct index portfolios. A big change would be for the major broker-dealers to approve 351s, he noted. “As there is more history and more assets and as the process gets more efficient and built out … it unlocks more doors,” he said. “And each of those doors is exponential, next-level on assets.”