By Amey Stone
You know what they say about the best laid plans.
The Alpha Architect 1-3 Month Box ETF, better known by its ticker, BOXX, launched at the end of 2022 with a goal of earning the so-called risk-free rate of a very short-term Treasury bill while limiting taxes. Yet BOXX recently delivered taxable gains to its investors, and some aren't happy about it.
BOXX uses a low-risk options strategy known as box spreads, a tool familiar to institutional investors but never tried before in an exchange-traded fund. The goal is to avoid paying out any income, allowing investors who hold the fund for at least a year to pay a long-term capital-gains rate when they sell, as opposed to the income-tax rate. For people in the top federal tax bracket, there's a significant difference: 20% versus 37%.
The concept caught on with investors who were enjoying the 5%-plus rates available in money-market funds, but weren't so pleased to lose a big chunk of the income to the Internal Revenue Service. The niche ETF now has $3.9 billion in assets, about $3 billion of which were added in only the past six months, according to Morningstar.
Surprise, surprise. But in early August the ETF did what it had tried to avoid -- distribute taxable gains: a short-term gain of 12 cents a share and a long-term gain of 17 cents, or a total of 29 cents, which was payable Aug. 14. The fund's net asset value per share is $108.37, which reflects a gain of about 8%, net of distributions. It returned 5% in 2023 and is up 3.3% year to date in 2024.
Although the taxable distribution is small, it nonetheless caught some investors by surprise. For example, on a Yahoo! Finance message board, one investor wrote, "I bought it for a trust I manage that I am trying to keep annual income below $100 so I don't have to file a tax return. Now, surprise!, they are issuing both long term and short term capital gains."
Alpha Architect CEO Wesley Gray says the distribution was recommended by the fund's legal and tax advisors. "We always seek to minimize distributions and taxable burdens for our shareholders when we are able to do so, but we can't guarantee, nor have we ever claimed, that the fund would never make a distribution," he tells Barron's Advisor.
Lan Anh Tran, a research analyst with Morningstar, says her understanding is that the taxable gain was due to the fund's initial use of S&P 500 index options, which can trigger a 60/40 long-term/short-term capital gains treatment.
"They have since switched to options on SPY ( SPDR S&P 500 ETF), which can take advantage of the in-kind process to avoid triggering capital gains and are not required to be marked to market at year end," she says.
That suggests the fund may not be required to distribute gains in the future -- at least for this reason. However, there is still some question about whether the fund might run afoul of the anticonversion statute that says funds that produce interest-equivalent income need to pay tax as it accumulates, Tran says. Steve Rosenthal, a senior fellow at the Urban-Brookings Tax Policy Center, wrote in March that BOXX "violates both the letter and the spirit of the anticonversion statute." So far, that question remains outstanding.
This content was created by Barron's, which is operated by Dow Jones & Co. Barron's is published independently from Dow Jones Newswires and The Wall Street Journal.
(END) Dow Jones Newswires
August 26, 2024 13:56 ET (17:56 GMT)
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