Brokers ditching loss-making bonds to achieve tax benefits

With the benchmark Standard & Poor's 500 Index up around 25pc for the year, financial advisors are looking to sell some of their worst-performing bond funds before the end of December, in order to book losses to offset capital gain taxes on their stock portfolios.

While tax-motivated selling is common at the end of any year, what makes 2013 different is that investors are offloading popular bond funds offered by giants like Pimco, T. Rowe Price and Vanguard, rather than riskier stock funds.

"There's not a whole lot of other losses out there," said Timothy Courtney, who oversees $1.2bn in client assets as the chief investment officer at Oklahoma City-based firm Exencial Wealth Advisors.

The broad bond market is down more than 4pc for the year, hurt by expectations that the Federal Reserve would soon begin pulling back on its $85bn a month stimulative bond purchases.

Some advisors say they may not move money back into bond funds in 2014, even after the 30 days they are required to wait before repurchasing an investment on which they claimed a loss.

"Every year we see investors running from bad performance when they set their new asset allocations," said Todd Rosenbluth, director of mutual fund research at S&P CapitalIQ. "Investors want their money to work for them, and bond funds certainly haven't been delivering like they used to."

Bond funds are supposed to be stable investments that provide a steady dividend income at lower risks than alternatives. But uncertainty over the Fed's move has dogged the market in the second half of 2013 and helped push bond prices down, sending yields higher.

Investors ploughed $131bn into the bond market in the first half of the year, before pulling some $85bn out of US bond mutual funds between June and November, according to estimates from Lipper, a Thomson Reuters company.

Outflows may accelerate towards the end of the year, said Tom Roseen, head of research services at Lipper, due to so-called "window dressing," when portfolio managers pull losers out of their portfolios before clients can read about them in year-end reports.

For the year to date, the $14.6bn iShares Core US Aggregate Bond index -- a proxy for the US bond market as a whole -- has dropped 4.1pc. Some sectors -- such as inflation-protected bonds and emerging market debt -- had steeper declines as commodity prices fell.

An unusual number of the year's worst-performing large mutual funds and ETFs are primarily invested in bonds. Typically, they are tilted more towards stock funds or commodities funds, both of which tend to take larger risks or use leverage that can compound losses.

This year, however, 73 out of the 168 mutual funds with more than a $1bn in assets and losses of more than 3pc for the year are bond funds, according to Lipper data.

Several investor mainstays are among the underperformers. The $16.8bn PIMCO Real Return fund, which focuses on inflation-protected bonds, has tumbled more than 8.5pc for the year. The $3.9bn T. Rowe Price International Emerging Markets Bond fund has dropped 8.3pc, while the $1.5bn Vanguard Long-Term Treasury fund has shed 12pc.

Those losses have put bond fund managers on the defensive. In an August letter to clients, Pimco's Bill Gross urged investors not to "give up on bonds."

"Bonds -- while containing a certain amount of maturity risk by very definition -- will never be antiquated," Mr Gross wrote. The Pimco Real Return fund has had outflows of $6.9bn in its combined share classes for the year through the end of November, according to Morningstar, compared with net inflows of $1.8bn in 2012 and $1.3bn in 2011.

Mr Courtney, the Oklahoma money manager, said that he has already completed his selling for the year, and he is not planning on adding more bond exposure in the new year.

"We're expecting to be underweight bonds for a while," he said. (Reuters)