Exclusive Interview: Invesco’s John Frank and Nick Kalivas

Tax-Loss Harvesting Before Year End – And A Look at Factor ETFs

Ric Edelman: You're listening to The Truth About Your Future. I always like to bring on some really impressive guests onto the show to help you get the most out of your money and making sure you're making the right investment decisions and managing your portfolio correctly. So I'm really excited to bring along these two very high-quality executives and very renowned gentlemen in the field of personal finance. First, John Frank. He's the head of ETF specialists for Invesco and Nick Kalivas, who is the head of Factor and Core Equity product strategy at Invesco as well. You see both of these folks quoted in the trade press all the time. They were quoted in The Wall Street Journal and at Barron's, The New York Times, they're on CNBC. John, let me start off with you and thanks for joining me on the show. Normally when folks think I'm talking to people from Wall Street, especially investment managers and strategists such as yourself, people think that we're going to be talking about investments. But what's equally important are the taxes on their investments. And people tend to think about taxes little, if ever, when they're looking at their investments. 

John Frank: That's so true. I think it's one thing too, that is very much in our control and that can have quite an impact on the portfolio.

Ric Edelman: And we've got to remember that it's not what we earn that matters is what we keep net of tax. So drill into that for us. John, what do people need to be thinking about when it comes to managing their taxes related to their investments?

John Frank: First is, it's tax-loss harvesting. So no one likes to have negative returns but think of it as really the negative turn can actually have an impact on the portfolio and if taken advantage of that negative return, to minimize the taxes you pay in the current period.

Ric Edelman: That's really a huge thing. In fact, what you've just highlighted is that we have finally found a way to be happy about the fact that the stock market has done so poorly this year. For you to take advantage of tax-loss harvesting, you have to have losses in the account. And for the past decade, really there really haven't been losses. The market's been continually rising. This year, the stock market's down 20% and this creates the opportunity to turn lemons into lemonade. So explain how tax loss harvesting works.

John Frank: So tax-loss harvesting really is about taking advantage of the losses. You have an investment portfolio or a single investment. So think about it. If you purchase an investment, let's say for $10,000 and it goes down by 20%, which unfortunately is not too atypical in the last 18 months. So now that $10,000 investment is worth about $8,000. What you can do by harvesting the loss means you've got to sell the investment. Sell the investment at $8,000. And then the next part is you want to maintain exposure. We assume that that investment was doing something in your portfolio. So you replace it with not the exact same thing (and it can't be substantially the same is defined by the IRS). And what you do is you're able to take that $2,000 loss. You can also use it against a capital gain distribution which could be coming.

Ric Edelman: So this is a really wonderful opportunity that as we approach the end of the year, people need to really be thinking about This is a way for you to make the most of a lousy year, that although you've got losses in the account, you can lower your tax bill as a result of this. So if you haven't considered tax-loss harvesting, you really need to talk to your financial advisor, you need to talk to your tax advisor and do it before the end of the year so that you can capture it. But that's not the only way that people can improve their investments, John, by paying attention to taxes. There are some ETFs on the market that are better at lowering your taxes than others. Talk about that.

John Frank: Yes, people think ETFs and mutual funds are more similar than they actually are. But at the end of the day, when we looked at last year, mutual funds paid an average capital gain of 9.0%. So that means if you had $100 investment at the end of the year, about $9 came back to you via the form of capital gains which you'd owe taxes on. On the ETF instead of 9%, it was 0.6%. So ETFs can't get rid of capital gains, but they do a great job of minimizing it. So as an investor, that just means the amount of taxes you owe the government is minimized.

Ric Edelman: And that is like an incredibly powerful thing. If you can drop your tax bill by so much merely by owning a tax efficient ETF. And that's one of the big claims to fames that Invesco offers, which is why Invesco is one of the largest ETF providers in the country. So you've really got to look at your portfolio. Do you get annual capital gain distributions? December's coming up. This has been a very volatile year. Fund managers have been doing an awful lot of trading, trying to minimize the damage from the decline, capturing the upside that occurred in the summertime. And it's creating a lot of churn. And in an ordinary mutual fund, as John has just expressed, that's going to create a massive tax liability for you at the end of the year if you're in an ordinary taxable mutual fund. So you really need to make sure you're using tax efficient investments. And I strongly encourage you to talk to your financial advisor about Invesco ETFs for exactly that reason. John, I really appreciate that explanation. Nick, Let me shift over to you. Mutual funds are typically managed by a fund manager. They're trying to pick stocks that are going to grow faster than other stocks. They're trying to beat the overall market. You contrast that to ETFs; they're typically tracking an index. They're not trying to beat the market. Their approach is a different way of doing business. Talk about which of these two approaches you think is better.

Nick Kalivas: It really boils down to a choice. But I'm going to be biased because I'm in the ETF business and kind of spend my days and my work life very dedicated to the ETF. And let me try to shed some light on some of the similarities between active managers and ETFs. And I like to think about the efficiency of the ETF wrapper, the transparency of the ETF wrapper, and the lower cost efficiency. Those are things that  give some edge to the ETF in terms of gaining exposure. Now, when you think about active managers, they use strategies or stock selection methodologies in their investment process. When you get into ETFs and especially the Invesco lineup, which I am focused on, smart indexing or factor-based indexing, those ETFs are using some of the exact same strategies that active managers use. They are strategies in the ETF based on underlying indexes that screen for stocks or screen for stocks in the stated strategy, say value growth. And they reconstitute. They rebalance periodically to maintain that exposure and avoid drift. The ETF process is very systematic. It's very rules based. It's transparent. They've just have removed the human element to that.

Looking Under the Hood of an Invesco ETF

And let me give you an example. Here at Invesco, we have an S&P 500 GARP ETF, the ticker on that is SPGP.  It takes the S&P 500 and it screens for the 150 stocks that have the fastest earnings and sales growth over the last three years. So that's something an active manager might try to do. Once it has that pool, it then picks the 75 with the lowest valuation. So, the cheapest stocks and the highest quality characteristics and it weights them by their growth score and it repeats that process twice a year. And so I think that that gives you a feeling here that the ETF can be very dynamic and strategic in the selection process. Moreover, these indexes that drive the ETF, there is an index provider behind them and they provide a lot of information and back tested history. So if you want to do due diligence, you can see how the strategy performed in different market environments, different regimes. You kind of know how the strategy is going to act because it's systematic and rules based. With a human, you just don't know. They could react differently to different environments, and I think that's helpful in terms of the construction process. So really the ETF goes a long way towards doing what active management can do but doing it in a more tax efficient and probably cost-efficient way.

Ric Edelman: That's one of the big differences between the two that I think a lot of investors don't realize. This is a wonderful opportunity, especially in today's volatile marketplace, to reevaluate the investments you're holding to see if they are properly positioned for the kind of environment we are finding ourselves in today and what is likely to be coming for years to come. And that's why you should take a real serious look at the Invesco ETFs, because I think you'll find a unique set of ETF opportunities that you may not be all that familiar with. And in fact, one of those, Nick, is something that we're starting to (at least I'm starting to) see more and more conversation about this in the marketplace. But I think most investors, most people listening to this show are not really familiar with. They're called Factor ETFs. Talk about what they are and how they work.

Customizing Your Investment Strategy with Factor ETFs

Nick Kalivas: Factors is a very kind of esoteric term that is kind of emanated from academic circles where there's a lot of research on investment done, but it's just grouping stocks by similar characteristics. Just kind of think about the S&P 500 so you can think about all the stocks in the S&P 500. We take the 100 stocks with the lowest volatility, just start dicing and splicing a universe of stocks into portfolios of similar characteristics. And what is interesting is that these different groupings have differentiated return and risk characteristics. You can use them to kind of raise your return, lower your risk or diversify your portfolio too. And really the ETF wrapper is very good for that. And as John mentioned, the process helps to shield the investor from a capital gains perspective.

Ric Edelman: You know, I've spent time at Invesco's website and you have a very broad array of ETF opportunities and it's fascinating as you go through them. It's fun process to see how different you can construct portfolios, how you can alter your emphasis on the kinds of stocks that you want to invest in. And Invesco has a lot of tools and information on its site that makes it really easy. And you can also, of course, talk to folks at Invesco who can help you identify where your levels of interest are, what you find of greatest value, what you consider to be the direction you want to emphasize in your portfolio. And Invesco makes this really easy through its broad array of ETF options. And you should also talk with your financial advisor if you have one, about this as well. This is not a one size fits all environment anymore in the stock market, and there are only a few fund companies that make this wide array available to you. And I think you do yourself a favor by looking at Invesco and you'll quickly begin to understand why they're one of the oldest and biggest ETF providers in the country. That is John Frank, the head of ETF specialists at Invesco, and Nick Kalivas, the head of Factor and Core Equity Product Strategy at Invesco here on the Truth About Your Future. John and Nick, thanks so much for joining me on the show.

Nick Kalivas: Thanks for having us. Ric.

Ric Edelman: Yeah, we actually had a longer conversation than you saw here on the program. If you'd like to watch, listen or read the entire conversation, just visit TheTruthAYF.com.