"Wrapper swapping" for tax benefit

I never heard of “wrapper swapping” before. It’s a technique to minimize taxes.

Bond Investors Swap Mutual Funds for ETFs at Record Pace

Amount invested in exchange-traded funds climbs to 21% of bond-fund assets

By Eric Wallerstein and Heather Gillers, The Wall Street Journal,
Dec. 10, 2022

Worn down from record losses, investors have fled bond mutual funds en masse. But many aren’t quitting on bonds—they are just turning to exchange-traded funds.

One main reason: taxes. Some investors sell beaten-down positions in bond funds to harvest tax losses. In many cases this year, investors have opted to put cash into similar ETFs to maintain bond exposure in their portfolios. As long as the securities within the ETF aren’t nearly identical to those in the mutual fund, swapping the so-called wrapper around the holdings allows investors to stay invested, while capitalizing on tax benefits…

This year is shaping up to be the biggest “wrapper swap” on record. Roughly $454 billion has been pulled from bond mutual funds on net while $157 billion has entered bond exchange-traded funds through the end of October. … Many wrapper swappers are plowing cash into Treasury ETFs from hard-hit mutual funds holding riskier bonds… [end qutoe]

In a nutshell, ETFs have fewer “taxable events” than mutual funds—which can make them more tax efficient. From the perspective of the IRS, the tax treatment of ETFs and mutual funds are the same. Both are subject to capital gains tax and taxation of dividend income. However, ETFs are structured in such a manner that taxes are minimized for the holder of the ETF and the ultimate tax bill (after the ETF is sold and capital gains tax is incurred) is less than what the investor would have paid with a similarly structured mutual fund.

The “wrapper swapping” described in the article is about bonds but would be equally applicable to stocks. They discuss changing two variables – the “wrapper” (ETF vs. mutual fund) and also the risk level of the specific fund.



Similar strategies work with companies which issue ADR’s from more than one different country. A couple of recent examples are BHP which has (had?) shares from both the UK and Australia in competing ADR’s as well as Royal Dutch Shell (UK, Netherlands), Unilever and so on. There are also frequently OTC market symbols ending in “Y” for foreign stock with US Dollar ADR’s and ending in “F” for the foreign shares as converted to USD (unhedged). These may not be a liquid as trading directly on the foreign exchange (say, through Interactive Brokers).

I currently own numerous foreign ADR’s as well as stocks on three foreign exchanges in local currency (AUD, CHF, JPY) in my portfolio and have, on a number of occasions used this strategy.