September 26, 2012 / 8:00 PM / 5 years ago

HOW TO PLAY IT-Getting an early jump on year-end investing

NEW YORK, Sept 26 (Reuters) - The calendar may say September, but some investors are already acting like it’s the end of the year.

It’s not uncommon for investors to sell lagging stocks in December to create tax losses that offset capital gains, and then buy the same or similar stocks in the next calendar year - a phenomenon known as the January effect. But with the benchmark Standard & Poor’s 500 index up 14.6 percent for the year through Tuesday and the possibility that the capital gains tax rate could jump come 2013, some investors are no longer waiting to sell.

“This used to be called the January effect, but now it’s moved into (the fall),” said Michelle Clayman, lead portfolio manager of the $274 million Calvert Capital Accumulation Fund .

To take advantage of calendar-based investing, some advisers are selling their best-performing stocks to stay ahead of possible tax increases on capital gains and dividend income. Other s tr ategists recommend unloading the worst-performing stocks in the S&P 500 now, before a common end-of-year drop when fund managers cut laggards from their portfolios. And some advisers are looking for closed-end mutual funds that could be trading at a discount because of tax-motivated selling.

Here are some of their strategies.


David Kostin, chief U.S. equity strategist at Goldman Sachs, advocates selling or shorting stocks early in the fall.

When shorting a stock, an investor borrows and sells it, speculating that the value will fall so he can buy it back at a lower price, return it and pocket the difference.

Since 1980, shorting the 50 worst-performing stocks in the S&P index at the start of the fourth quarter has generated a median return of 2.05 percentage points more than the broad index through the end of the year, he wrote in a Sept. 21 note to clients. Laggards this year include companies like Apollo Group, DeVry Inc, Alpha Natural Resources , Humana and Electronic Arts, which are all down by 20 percent or more this year.

Meanwhile, other strategists say that picking up the laggards that others are selling can offer short-term gains.

Pankaj Patel, a quantitative strategist at Credit Suisse, said that money managers tend to sell their worst-performing stocks for the year between October and December, when most U.S. mutual funds end their fiscal years. Managers want to avoid reporting these holdings in their year-end report, a tactic called “window dressing.”

Yet this wave of selling, which overlaps with tax-loss harvesting, can make these stocks undervalued, setting the stage for a rally through the end of January, he said. These turnaround stocks have outperformed the S&P 500 over that time each year since 2005, according to Credit Suisse research.


Tax-motivated selling may be more prevalent this year because of a combination of tax increases and government spending set to take place in January, analysts said.

If Congress doesn’t intervene, scheduled tax increases for 2013 mean the top rates on dividend income could increase to as much as 43.4 percent from the current rate of 15 percent. Capital gains taxes, meanwhile, would increase to 20 percent for most investors from the current 15 percent.

Cam Albright, director of asset allocation at Wilmington Trust Investment Advisors, said he usually doesn’t advocate calendar-based investing, but that this year may be unique.

“If you have some fairly significant gains, there would be a significant after-tax benefit in selling this year instead of next,” h e said.

With the S&P 500 trading near a 4-year high, Albright said he’s planning to sell some positions and lock in gains this year, rather than waiting until 2013.

A pickup in tax-motivated selling could also make closed-end mutual funds more attractive, said Gregory Neer, a research analyst at Relative Value Partners, a Northbrook, Illinois-based investment adviser.

Shares of closed-end funds represent a stake in a portfolio of securities. T here are a fixed number of these shares so they don’t offer the same liquidity as open-end shares. They can then trade at a premium or discount to the net asset value of the portfolio itself.

Neer said investors in closed-end funds sometimes sell positions in late October or early November to create tax losses to offset other income. The result: shares in these funds then may trade at a discount to the underlying value of the fund.

Of course, this can work both ways: one risk to buying any closed-end fund is that shares can be illiquid and force an investor to sell at a discount when trying to unload the position.

Neer looks for funds in which shares trade at a 5 percent discount or more to the fund’s net asset value. This discount often narrows in January as buyers return to the market, creating a short-term boost for share prices.

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