These ETFs Are Hoping to Skip the Dividend Tax

Fixed-income ETFs are booming. They’re also becoming more tax-efficient than ever.

Fixed-income strategies garnered more than a third of total ETF sales in the first half of this year and recently surpassed $2 trillion in AUM. The latest firm to capitalize on the explosion is the boutique issuer F/m Investments, which recently launched a new series of passive, fixed-income funds designed to minimize dividend tax drag. It’s the latest effort to capitalize on widespread adoption of fixed-income ETFs that are tapping into institutional investors, said Todd Rosenbluth, head of research at VettaFi. “Institutional adoption of fixed-income ETFs has accelerated as the liquidity has improved,” he said.

In the Rotation

F/m’s funds work by investing in other, similar ETFs that provide exposure to a buyer’s selected bond type, rather than receiving that income as a distribution. Once the original underlying ETFs have paid out their dividends, the two funds will rotate back into them, minimizing the taxes involved in distributions. Tax efficiency in ETFs is nothing new, but F/m’s funds bring even more tax benefits, said Alex Morris, CEO of F/m. The idea for the funds came about because the firm’s institutional investors wanted a product that wouldn’t keep giving them their money back, with the result being a product that would eliminate the distribution altogether. “Distributions are sort of a messy thing,” Morris said. “They’re not investor-friendly, they’re issuer-friendly … Practically, most investors aren’t really served well by that.”

The two funds are:

• The F/m Compoundr High Yield Bond ETF (CPHY), which prioritizes investment-grade bond exposure.
• The F/m Compoundr U.S. Aggregate Bond ETF (CPAG), which invests in high-yield bonds.

Looking to Europe. A similar set of funds is the Global X PureCap suite, which work around regulated investment company tax rules by “being creative” in providing exposure to different sectors, Rosenbluth said. These tax rules are what have prevented widespread adoption of what Europe calls accumulating share classes, which have been around for decades and let income build up in the fund by investing income in more shares. “America just forgot to do that, and we think we fixed that,” Morris said.