An ETF Strategy for Deferring Embedded Gains
Cambria Investments is exploring a new strategy in the ETF space by soliciting seed capital from investors and financial advisors who want to defer embedded capital gains.
A decade in the making, the Cambria Tax Aware ETF (TAX) is coming together through a partnership with Cambria and ETF Architect that will be funding the new ETF through an exchange of outside portfolio investments.
The strategy, which is comparable to a 1031 exchange commonly used to defer gains in real estate transactions, will enable investors to postpone paying taxes on capital gains while diversifying and reallocating portfolios.
As an initial investment, TAX will only appeal to investors with large portfolios that have somewhat concentrated positions of individual securities or ETFs. But the outside investments can’t be so concentrated that they violate the two main rules, including that the top five positions can’t represent more than 50% of the overall investment, and the largest position can’t represent more than 25% of the investment.
“We’re doing an open enrollment for anyone who wants to invest,” said Meb Faber, co-founder and chief investment officer at Cambria in Manhattan Beach, Calif.
Faber said the inquiries have been coming in fast and furious, but that the seed capital opportunity is not suited for everyone.
“We’ve had a ridiculous number of inquiries,” he said. “My inbox has been smashed and we haven’t even sent it out to our email list yet.”
In addition to publishing responses to frequently asked questions, Cambria is in the process of creating a landing page to help people pre-qualify their assets for investment over the next two months leading up to the introduction of TAX in December.
Unique Tax Deferment Opportunity
While the tax deferment opportunity is unique in the ETF space, there have long been strategies to postpone paying taxes on embedded gains across the financial services landscape.
Paul Schatz, president of Heritage Capital in Woodbridge, Conn., said he has never fully understood how it is allowed under the tax code.
“I know the practice has been going on for decades by the ultra-wealthy through firms like Goldman and Morgan, but what I could never understand is how the IRS code allows all of this,” he said. “I have asked CPAs and probably not the uber high end ones, but no one seemed comfortable advising my clients on this.”
Schatz added that, “I am sure Cambria and the like did their extensive due diligence, but it’s still hard to believe that the IRS leaves this loophole open.”
“With all that said, if it’s all legal it is a brilliant strategy for folks with very large, embedded capital gains,” Schatz said.
Beyond the initial fund-raising period, TAX will function as an actively managed ETF designed to replicate the performance of the S&P 500 Index without the dividends.
Faber said TAX is the first of at least three ETFs that will follow the same fund-raising format over the next several months.
The next ETF slated to debut will be a fund of ETFs, followed by a strategy designed around global shareholder yield.
