I don’t tend to cover the endless stream of ETF filings, because half of them don’t launch and the other half are mostly just Crypto and Leverage these days. But sometimes someone comes up with something so clever, and so obvious that it almost makes me annoyed. That it’s F/m Investments, who I’ve already said nice things about here before for being so boring, is even more annoying, because it’s going to look like I’m playing favorites (I have zero financial relationship with the firm, promise).

But I gotta call it: this filing from F/m is worth celebrating. Here’s what they filed for:

Six boring fixed income buckets. But boring, they ain’t. Let’s just pick the first one, CPHY: instead of investing in a pool of junk bonds, the fund invests in other junk bond ETFs as a fund-of-funds, but with an extremely clever kicker:

Let me simplify this:

The fund buys Junk Bond ETF A - its “Core” position.
When that Core position is ready to go Ex-Dividend — that is, when the dividend has been announced, but is still included in the NAV of the ETF, the fund rotates out of ETF A into an identified, very similar Junk Bond ETF B, the “Substitute” position.
Once the dividend has been paid out, the fund rotates BACK into the Core position.

Why is this so cool? It has several big, positive impacts on the holding investor:

The fund will likely never have to make a distribution of any kind, because it never receives any dividends, instead accumulating the total-return of the asset class. This makes it essentially a European style accumulating share class where dividends are automatically reinvested, or like an Exchange Traded Note that promises total return. This is extremely helpful if you’re holding in a taxable account and don’t actually want current income.
The fund will easily maximize its tax efficiency: like any other ETF, it can (probably) heartbeat trade a low-basis Core holding out to effect the “rotation” between ETFs, or, should it be holding the Core ETF at a loss, it can simply sell the position on ex-date, book the loss, and buy the Substitute.
This might even be an Alpha generating strategy (if they extend this strategy to dividend paying stocks) — at least according to academics and wonks like Brent Sullivan at Tax Alpha Insider, who note that “dividend-paying stocks tend to rise 41 to 53 basis points in the month they're expected to pay a dividend, only to drop 72 basis points over the next 40 days.” I am not holding my breath on this specific pattern holding for, say, rotating between JNK and HYG dividend dates, but at least the weight of the data is on this being a benefit, not a cost!

So What, Big Deal

There’s no magic here. This is actual investor-focussed innovation. While most of the industry seems to be content to try and slap leverage on everything and call it new, advisors know that the biggest game in wealth management is actual the Tax Game.

The challenge with tax-based innovation — as we’ve seen with 351 transfers, Box Spreads and Exchange Funds — is that the IRS looks unfavorably when the only purpose of a trade is to avoid taxes — that’s why the wash sale rule exists. Part of why this abysmally named “Compoundr” approach is so smart is that it fundamentally remaps the pattern of returns in a way that just so happens to be tax efficient, but also genuinely simplifies exposure to “high yielding” assets.

Could there be warts? I suppose the funds could come to market with too high a fee, or flop-on-arrival, like any other ETF, but the core logic seems sound to me. Turnover will obviously be high. But given that the target-ETFs are massive, highly liquid and easily arbitraged, I suspect the transaction costs will be de minimis. We’ll know more when the funds launch, most likely in August.

Although, I’d still like to buy F/m a vowel.

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Actual ETF Innovation: F/m's Compoundr…

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