Exchange-traded funds have been praised for their improved tax efficiency over mutual funds, but the ETF tax advantage only applied to stock funds. Until now.
Alpha Architect 1-3 Month Box ETF BOXX aims to replicate the performance of 1-3-month Treasury bills without the tax bill, and it has delivered so far.
Unlike a regular short-term bond fund, BOXX doesn’t produce income and gives investors the choice of when to realize capital gains, which makes it possible for investors to pay long-term capital gains tax rates on a T-bill-like investment. Investors have taken notice: BOXX, which was created in December 2022, recently reached $1 billion in assets.
We take a closer look at BOXX’s strategy, what it means for investors, and how the fund has performed.
BOXX is the first ETF intended to access risk-free rates via an options strategy called a box spread.
A box spread utilizes option contracts that cancel out risk exposures while insulating its payout from movements in the underlying security. The two positions in a box spread move in opposite directions, but they don’t cancel each other out at zero. The box’s payoff at expiration nets out at a constant, positive amount equal to the difference between the two strike prices. BOXX is effectively harvesting a risk-free rate of return from the box spreads.
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. 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.
This strategy allows BOXX to avoid realizing gains, which eliminates year-end gains distributions and allows the fund to be taxed like a stock. The fund has yet to distribute any capital gains since its 2022 inception, which shows that the management of the single-stock box spreads has offset gains from the S&P 500 box spreads.
What Does the BOXX Strategy Mean for Investors?
Cash plays an important role in portfolios. Individual investors may keep a portion of their portfolio in cash to meet short-term obligations. But an inverted yield curve means cash yields are higher—or at least competitive with—longer-dated bonds, making cash a worthy investment right now.
The problem with holding cash is that yield is taxed as ordinary income. That means paying up to a 37% tax rate on gains. Investors often seek out long-term capital gains tax treatment for other investments like stocks because the highest tax rate is only 20%.
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.
Of course, this only helps in taxable accounts. And the managers do not aim to regularly distribute income like a money market or bond fund, so this isn’t meant to be an income product. However, investors looking to optimize the tax efficiency of their cash may find this ETF to be an attractive alternative to a money market fund or T-bills.
How Has BOXX ETF Performed?
From its December 2022 inception through January 2024, it climbed by 5.03% annually, while the Morningstar US 1-3 Month Treasury Bill Index gained 5.12% annualized. Its performance has hewed closely to that of the index on a monthly basis, deviating at most by 8 basis points. Minimal deviations are to be expected, as Treasuries do carry a convenience yield over the options-derived risk-free rate thanks to their cashlike properties and eligibility for collateral.
BOXX Tightly Tracks the Performance of 1-3 Month T-Bills
The fund has reached the $1 billion mark for assets under management, but capacity should not be a concern in the near future. S&P 500 options are among the most liquid in the world. As of January 2024, average daily volume stands at over 3 million contracts, translating to nearly $1.5 trillion in notional value. Options with 30–90 days to expiration account for around 10% of the total volume on S&P 500 options, providing ample liquidity for the fund.
The author or authors do not own shares in any securities mentioned in this article.Find out about Morningstar’s editorial policies.
This Bond ETF Promises T-Bill Returns Without Taxable Income. BOXX may be a viable alternative to money market funds and other cash vehicles. Exchange-traded funds have been praised for their improved tax efficiency over mutual funds, but the ETF tax advantage only applied to stock funds.
Tax considerations: Interest income from Treasury ETFs is subject to federal income tax, though it is typically exempt from state and local taxes. In addition, any capital gains from selling ETF shares are subject to capital gains tax.
The Alpha Architect 1-3 Month Box ETF, known as BOXX, uses options to generate a return similar to short-term Treasuries, but with tax advantages. Each month, the T-bill ETF distributes taxable income to its shareholders, reflecting interest harvested from the short-term Treasuries it owns.
The interest income that you may receive from investing in a treasury bill is exempt from any state or local income taxes, regardless of the state where you file your taxes. However, you will need to report interest income from these investments on your federal tax return.
Interest from Treasury bills (T-bills) is subject to federal income taxes but not state or local taxes. The interest income received in a year is recorded on Form 1099-INT. Investors can opt to have up to 50% of their Treasury bills' interest earnings automatically withheld.
Unlike a regular short-term bond fund, BOXX doesn't produce income and gives investors the choice of when to realize capital gains, which makes it possible for investors to pay long-term capital gains tax rates on a T-bill-like investment.
One common strategy is to close out positions that have losses before their one-year anniversary. You then keep positions that have gains for more than one year. This way, your gains receive long-term capital gains treatment, lowering your tax liability.
The Bottom Line. Treasury Bills, or T-bills, represent short-term debt obligations by the Treasury. Because the U.S. government backs them, they are considered extremely low-risk, although they also have relatively low returns.
Like T-bills and T-bonds, Treasury notes are generally considered to be below-risk and highly liquid fixed-income investments, backed by the US government. Income exempt from state and local taxation; federal tax due each year on interest earned.
When short term T bills mature, the interest income is mistakenly shown as capital gains in tax reports. The interest is taxable on Fed, tax exempt on most states. T bills are short term zero coupon purchased at a discount and paid at face vale at maturity.
As a result, T-bills have interest rate risk meaning there is a risk that existing bondholders might lose out on higher rates in the future. Although T-bills have zero default risk, their returns are typically lower than corporate bonds and some certificates of deposit.
To calculate the price, take 180 days and multiply by 1.5 to get 270. Then, divide by 360 to get 0.75, and subtract 100 minus 0.75. The answer is 99.25. Because you're buying a $1,000 Treasury bill instead of one for $100, multiply 99.25 by 10 to get the final price of $992.50.
If you buy a bond when it is issued and hold it until maturity, you generally won't have a capital gain or loss. However, if you sell the bond before its maturity date for more than you paid for it, you'll typically have a capital gain. If you sell it for less than you paid for it, you'll usually have a capital loss.
The IRS treats interest earned on money in a savings account as taxable income. Your financial institution issues a 1099 form if you earned at least $10 in interest in the previous tax year.
CLIP will primarily invest in Treasury bills, making it an attractive option for investors seeking to potentially minimize credit and interest rate risks.
Vanguard Intermediate-Term Tax-Exempt Bond ETF is designed for tax-sensitive investors with an intermediate-term time horizon and a preference for passive management. The new ETF has an expense ratio of 0.08%, compared with the average expense ratio for competing funds of 0.37%1.
Because the income from U.S. Treasury securities is exempt from state and local income taxes, the fund generally expects that the majority of the dividends it pays will be exempt from those taxes as well. (Dividends still will be subject to federal income tax.)
T-Bill ETFs offer investors a diversified portfolio of T-Bills by employing a rules-based approach to security selection and weighting. This helps reduce the reinvestment risk, the hassle associated with investing in a single T-Bill, and ensures a low and stable duration.
Introduction: My name is Francesca Jacobs Ret, I am a innocent, super, beautiful, charming, lucky, gentle, clever person who loves writing and wants to share my knowledge and understanding with you.
We notice you're using an ad blocker
Without advertising income, we can't keep making this site awesome for you.
