As we approach the midpoint of the fourth quarter, many financial advisors will be assessing both losses and gains (given the political election next year) in their portfolios for the year. 2023 has indeed been an interesting year in the markets with the S&P 500 up 9% on the day this memo was written, while large-cap value and small-cap stocks are down 4% and 6% year to date, respectively. We won’t even talk about bond portfolios…

Surely, the performance discrepancies within both the equity and fixed income markets can create challenging client conversations at year-end review time. As a former advisor, I know firsthand the difficult position advisors are in this year with clients. Clients tend to mentally track the S&P 500 as a gauge of their overall portfolio performance, only to find that a fully diversified 60/40 portfolio is roughly flat by many metrics…stemming from a lousy 2022 with regards to performance.

With this in mind, advisors may want to consider tax-loss harvesting to offset the gains clients have realized in their portfolios this year, while locking in losses to potentially offset those gains. Tax-loss harvesting can also be a way to remove an ugly line item from statements come year end.

If you are considering tax-loss harvesting this quarter, Structured Notes may be a tool to take advantage of and implement this strategy.

For starters, advisors should look at their current Structured Notes and see which ones have a loss. For those positions that are reflecting a loss, advisors may consider selling that position and rolling the proceeds into a similar Note. This harvesting approach may afford advisors the opportunity to get more protection (for example, resetting the protection at lower levels) and lock in higher participation rates compared to the Note they currently own.

How can you achieve a higher participation rate? Typically, when the market is down, volatility is higher. When volatility is higher, generally terms on Structured Notes can be better since the two major components of a Structured Note’s pricing are based on interest rates and volatility. As they go up, so do the terms of Structured Notes in many instances.

In summary, harvesting losses from a Note can allow an advisor to lock in a loss for tax purposes, but it can also position the advisor to “reset” a Note with potentially better investment terms.

Another strategy advisors may consider is tax-loss harvesting long-equity positions and rolling the proceeds into a Structured Note. This may make sense because an advisor is playing both “offense and defense” at the same time.

Envision the following hypothetical conversation: An advisor is explaining current portfolio losses to a client and the client would like to harvest them. “Yes, you are capturing losses to offset realized gains,” the advisor tells the client, but communicating losses to clients is never easy, no matter how normal it is. If the advisor takes those harvested proceeds and rolls them into a passive ETF, so as not to trigger wash-sale rules, the client may naturally ask, “what makes you confident the market won’t fall more from here?” The advisor, of course, does not have a crystal ball, and riding out the market after experiencing losses becomes more and more challenging for the client as time goes on.

Instead, a more productive conversation may be to explain to the client you are harvesting losses and rolling them into a Structured Note. “With a Structured Note…”, the advisor tells the client, “…we are rolling the proceeds from harvesting into an investment that gives us the same market exposure, but comes with a level of downside protection in the event the market continues to fall, and also comes with enhanced upside if the market rallies.” As a result, the conversation turns from being defensive into one that is offensive — the advisor is proactively managing a client’s tax sensitivities, while inserting a level of protection. If or when the market goes up, the client will not only participate in the upside, they can get enhanced upside, potentially making up for losses faster than they would if they just bought a passive index fund. I like to call this harvesting technique an “Equity Repair Strategy.”

In conclusion, whether you are harvesting losses in existing Structured Notes or harvesting your long-equity exposure, rolling the proceeds into a Structured Note can allow for more productive client conversations in what has been another challenging year.

When using Structured Notes, advisors can provide their clients some comfort of knowing they have a level of downside protection and the opportunity to outperform the market with enhanced upside. Given we are in the heart of football season, this could be a strategy where both “offense and defense win championships.”

As always, this is an idea that is intended to spark more productive conversations with clients and prospects. This is not intended to be financial or tax advice, and please consult with a tax advisor in regards to various tax-harvesting strategies, regardless of how you implement them.

That said, Halo is here to help financial advisors with any Structured Note questions. Halo is powered not just with award-winning technology, but with a team of experienced professionals who can help guide advisors through the process.

An investment in Structured Notes may not be suitable for all investors. These investments involve substantial risks. The appropriateness of a particular investment or strategy will depend on an investor’s individual circumstances and objectives.

Please see our Halo Disclosure Page for important disclosures.