For investors, ‘tis the season for tax-loss harvesting – and picking up stocks on the cheap.
Selling stocks or exchange-traded funds (ETFs) deliberately at a loss may not be a very appealing strategy as year-end holiday expenses begin to pile up. But if these assets are held in a non-registered account, investors can reap savings from selling these securities at a loss to offset taxable capital gains. And unused capital losses can be carried back three years or forward indefinitely.
This time of the year can also be ideal to snap up bargain stocks as market participants dump their dogs and fund managers engage in “window dressing” as they sell losers and buy winners to buff up clients’ year-end statements.
“Buying opportunities can arise, but it’s not like shooting fish in a barrel,” says Ryan Modesto, chief executive officer at Waterloo, Ont.-based 5i Research Inc., an independent investment-research firm.
It’s best to have a shopping list, particularly of small- to mid-cap stocks because they typically get hurt the most, he says. “The first two weeks of December is when you want to sharpen your pencil to look at names that are getting sold off.”
Although there were plenty of tax-loss candidates when the S&P/TSX Composite Index dropped by 12 per cent in 2018, there are fewer losers this year when the market is up by about 19 per cent. Many beaten-up names are energy and cannabis stocks.
Canopy Growth Corp. (WEED-T), Aurora Cannabis Inc. (ACB-T), Cronos Group Inc. (CRON-T) and Tourmaline Oil Corp. (TOU-T), which analysts expect to have annual revenue growth of at least 15 per cent, are potential tax-loss prospects because their stocks are off by more than 20 per cent this year, Mr. Modesto says. (The stock-screen tool he used to find these stocks showed that Canopy expects annual revenue growth of about 56 per cent.)
If they get unduly beaten up despite having good growth potential, then they “may be names investors want to keep an eye on for an attractive entry point,” he says, noting that his firm does not have an opinion on these stocks.
The deadline to trigger a capital loss is Dec. 27 for the 2019 taxation year. Investors must wait 30 days after selling a stock or an ETF at a loss before they can buy back the security. Otherwise, the Canada Revenue Agency (CRA) does not recognize the tax loss.
Investors may want to sell a depressed stock because the company’s prospects have waned from a change in strategy, a heavier debt load or a more competitive environment, Mr. Modesto says.
Those investors who are more motivated to get rid of losers to cut their tax bill but worry about missing a bounce-back in their stocks within 30 days might consider selling a lower volatility name that’s unlikely to rally sharply in the shorter term, he says.
For example, an investor could sell an underperforming Canadian telecommunications stock (Rogers Communications Inc. [RCI-A-T or RCI-B-T] fits the bill this year), but also buy shares of one of its two big competitors to keep similar market exposure, Mr. Modesto suggests.
If investors sell a more volatile technology stock but are still bullish on the name, they might see its shares “potentially jump by 10 per cent in 30 days, and that would overshadow any tax-loss benefit,” he says.
Investors can retain exposure to a stock sold for the tax loss by buying an ETF that tracks that sector, owns that name and moves closely in tandem, says Daniel Straus, vice-president, ETFs and financial products research, at National Bank Financial Inc. in Toronto.
“They won’t get that stock-specific move, but will at least participate in a sector rally should that occur in the one-month window,” says Mr. Straus, whose team recently released a report on tax-loss strategies using ETFs. “They can cycle back into the stock after 30 days … or not switch if they’re happy with the ETF.”
As an example, investors could sell shares of uranium producer Cameco Corp. (CCO-T), which have slumped this year, and buy Horizons Global Uranium Index ETF (HURA-T) to maintain exposure to its sector, he says. (Cameco is the top holding in that fund, at 22 per cent.)
BMO Junior Oil Index ETF (ZJO-T) could be a replacement for beaten-down energy stocks such as Vermilion Energy Inc. (VET-T), MEG Energy Corp. (MEG-T) and Seven Generations Energy Ltd. (VII-T) while iShares S&P/TSX Capped Information Technology Index ETF (XIT-T) could be an alternative for slumping BlackBerry Ltd. (BB-T) shares.
Evolve Marijuana ETF (SEED-T) is a cannabis-sector option for battered stocks such as HEXO Corp. (HEXO-T), Aurora Cannabis and Aphria Inc. (APHA-T). Horizons Marijuana Life Sciences ETF (HMMJ-T) may be a better alternative for Canopy Growth and Cronos because these stocks’ weightings are higher in this ETF.
However, investors who want to sell a money-losing ETF and switch to a similar fund must avoid buying another ETF that tracks the same index because the CRA won’t recognize the capital loss, Mr. Straus cautions. “It must be a sufficiently different fund.”
Steve DiGregorio, a portfolio manager in Montreal with Canoe Financial LP, expects a lot volatility as investors sell beaten-up, smaller-cap stocks for tax losses because these names are not easily tradeable.
And stocks that are not largely owned by mutual funds or pension managers typically get hit harder because they will have less support when they’re sold for tax purposes instead of fundamental reasons, he adds.
Aurora Cannabis, BlackBerry, Baytex Energy Corp. (BTE-T), Uni-Select Inc. (UNS-T), Husky Energy Inc. (HSE-T), Canopy Growth and Western Forest Products Inc. (WEF-T) – all of which have seen their stocks drop by more than 40 per cent since Jan. 1, 2018 – could be tax-loss candidates because they have low institutional ownership, Mr. DiGregorio says.
There should also be good buying opportunities in the Canadian preferred-share market, which has suffered amid falling interest rates, says Mr. DiGregorio, who manages Canoe Premium Income Fund. “Over nearly two years, the S&P/TSX Preferred Share Index is off by about 18 per cent.”
Frustrated shareholders and some preferred-share ETFs, which could see heavy redemptions, will likely “dump that paper,” he says. “You have an asset class that is illiquid, has fallen out of favour and whose shares are well below their purchase price.”
Mr. DiGregorio has a shopping list of 36 minimum-dividend rate-reset preferred shares in case they sell off sharply. These securities offer a minimum yield no matter how low interest rates fall, “whereas 70 per cent of the preferred-share market doesn’t have a minimum return,” he says. “That is problematic if interest rates grind significantly lower.”
His fund’s biggest preferred-share holding is Element Fleet Management Corp. Series I (EFN-PR-I-T), which has a minimum yield of 5.75 per cent and resets its dividend rate in 2022. “If it comes under pressure, I would without a doubt add that piece of paper.”