Trending
It’s been widely noted that as of the end of January, there was more than $6 trillion sitting in money market funds and other cash instruments. Undoubtedly, some of that cash will eventually come off the sidelines and make its way into stocks and bonds.
Still, some clients will want to keep some dry powder for the time being while generating risk-free income. Some exchange traded funds offer attractive alternatives to basic cash instruments and one of those products is the Alpha Architect 1-3 Box ETF (BOXX).
As its name implies, BOXX provides exposure to 1-3 month T-Bills – essentially a risk-free asset class. The ETF attempts to generate returns that are on par with or potentially excess of that form of U.S. government debt while being a more tax-efficient option than holding those bonds in direct fashion.
Advisors and investors have embraced BOXX as highlighted by the fact that it has more than $1.6 billion in assets under management at just 15 months old.
Understanding How BOXX Income Is Sourced
Obviously, clients are allocated to fixed income products in part because of the income. BOXX has that, but it arrives there is different than traditional bond funds.
The ETF uses an options-based strategy, but it’s not covered calls, which are prominent throughout the ETF universe. Rather, BOXX lives up to its ticker by using an options strategy known as, well, the box spread. In a box spread, an options trader uses contracts that essentially eliminate each other’s risk while providing a buffer against volatility in the underlying security. The income generated is derived from the difference between the contracts’ strike prices.
“BOXX buys a box spread using S&P 500 options and, separately, a box on single-stock options. The bulk of the portfolio is in S&P 500 options, while the managers invest a small stake in single-stock box spreads to increase tax efficiency,” notes Morningstar. “Short-term capital losses on the single-stock box can offset the index options’ short-term gain, and vice versa. These options can also be redeemed in-kind, meaning the fund managers can choose to shed gains on options through in-kind redemptions while taking losses on the options that are down money.”
Advisors are right to ask whether or not this strategy can increase returns. Since inception, BOXX has returned north of 5%, according to issuer data, while a basic 1-3 month T-Bill ETF was mostly flat over that period.
BOXX Tax Advantage
As advisors know, yields on cash are taxed as ordinary income and for some clients, that can mean being taxed at the highest rate of 37%.
For the most affluent clients, including those in the ultra-high net worth camp, BOXX could be appealing because its risk profile is comparable to cash with more tax advantages. Put simply, a client in the 37% bracket won’t pay that rate on income earned from BOXX.
“For BOXX, investors get cashlike risk and return, but they can choose when to realize capital gains from the fund when they sell their shares. Investors who hold the fund for longer than a year could pay long-term capital gains tax rates on cash, which isn’t possible for other cash alternatives. That would mean saving 17% of gains for investors in the highest tax bracket,” concludes Morningstar.
Related: Wealth and Well-being: Debunking the Myth that Money Guarantees Happiness