There’s been a lot of excitement and reporting about a new ETF: the Alpha Architect 1-3 Month Box ETF (BATS:BOXX), designed to give investors the return of short-term US Treasury Bills with the tax character of long-term capital gains.
Long-term capital gains are taxed at lower rates than interest income – 20% versus 37% for the top US federal tax rates. With short-term interest rates at about 5%, this 17% difference in tax rates provides 0.85% more annual after-tax return, and you can add another 0.07% if you use BOXX to defer your tax bill for 5 years. That’s pretty good, and worth paying attention to if you can get it.
Two excellent Bloomberg articles were published on Feb 22nd that do a terrific job explaining how BOXX achieves its tax “magic.” The first is by Zachary Mider, “T-Bills Without Tax Bills? and hours later came “Put the Money in the BOXX” by Matt Levine (and a few days later also by Matt there’s “Maybe Don’t Put the Money in the BOXX?”).
Since BOXX went live on December 22, 2022, its annualized return has been 0.09% higher than that of State Street’s SPDR Bloomberg 1-3 Month T-Bill ETF (NYSEARCA:BIL). BOXX has a stated expense ratio of 0.395%, but currently charges 0.195% and has about $1 billion of assets, while BIL sports an expense ratio of 0.136%, has $31 billion of assets and has been around for 17 years.
However, past returns are not necessarily indicative of future performance, and we think it’s reasonable to expect that BOXX’s prospective post-tax, risk-adjusted return relative to BIL (or direct ownership of Treasury Bills) does not justify owning BOXX. Before diving in, we should qualify what follows by noting that we are not tax experts, and we have not been in touch with the creators of BOXX to make sure we are not misunderstanding their product.2
Let’s start with an analysis of the expected return of BOXX, and then we’ll move to assessing the relative risk of BOXX versus Treasury Bills. First, BOXX has a higher expense ratio than BIL. The stated long-term expense ratio of BOXX is 0.395% per annum,3 compared to 0.136% for BIL. At the long-term expense ratio, that takes 0.21%4 out of the 0.85% of tax savings, leaving 0.64% of net tax savings versus BIL.
Next, there’s the question of what rate of interest will be set by market participants who provide the other side of the BOXX options trades. Historically, as discussed in this article from the NY Fed, the implied interest rate in options boxes has averaged about 0.35% above T-Bills (from January 1996 through April 2023). While this historical positive spread may continue into the future, it is worthwhile to ask yourself how you would price those options if you were being asked to be the counterparty to BOXX’s trades?
Your selling of the options box-spreads generates cash – the cash that the BOXX ETF wants to invest – but at the same time, you’ll need to post collateral to the clearing exchange. You need to do this to give comfort to your counterparty – the Options Clearing Corporation (OCC) – that if you disappear with the cash, they won’t have a loss.
You’ll probably go out and buy a T-Bill of equal maturity to the expiration of the options you traded and post that as collateral to the OCC. For this to be worthwhile, you’ll need to price the options using an interest rate lower than the T-Bills you had to buy to post as collateral, so you can earn a spread.
How much of a spread you’ll want to earn is a difficult question to answer beyond saying “as much as I can get.” Perhaps one place we can look for an indication of what market participants charge for nearly risk-free trades is the much-discussed Treasury bond basis trade. A number of recent articles (here and here) indicate that traders demand an expected return of at least 0.5% per annum on assets.
Read the full article here by Victor Haghani, James White, Advisor Perspectives
