In this episode of Advisor Wars, hosts Bob Huebscher (founder of Advisor Perspectives) and Joe Halpern (Managing Partner and CIO of Obsidian CIO) continue their series on the role of tax planning in the advisory profession.
This time they tackle one of the most talked-about yet least understood tools available to RIAs: Section 351 exchange ETFs and related tax-efficient diversification strategies.
Joining them is Meb Faber, co-founder and Chief Investment Officer of Cambria Investment Management and author of multiple books on investing. Faber's firm has run several Section 351 launches and is one of the few opening these exchanges to outside advisors and investors through open syndication. Concentrated and highly appreciated stock positions are one of the most common, and most expensive, planning challenges for wealthy clients.
After a 17-year bull market, many investors want to diversify but fear the tax bill, and the solutions go far beyond simply selling and paying the tax. Advisors who understand the full toolkit, including Section 351 ETF contributions, exchange funds, direct indexing, and long/short overlays, will be positioned to deliver far greater after-tax outcomes for their clients.
Key takeaways for advisors:
Tax alpha is the easiest alpha: Faber argues the "old, boring alpha" of fees and taxes is far simpler to capture than chasing market calls. Choosing the right structure can be worth 1.5% or more per year in a taxable account.
The ETF structure is the engine: The creation/redemption mechanism lets ETFs rebalance and defer gains rather than passing them to shareholders, the key reason ETFs are taking market share from higher-cost, less tax-efficient mutual funds.
Section 351, explained simply: A 100-year-old provision in the tax code now paired with the ETF wrapper. Contribute a concentrated or highly appreciated portfolio, receive a diversified ETF in return, and defer the gain. Think of it as a 1031 exchange for stocks. It's a deferral, not a tax wash.
Know the rules before you pitch it: The top position can't exceed 25% of the contributed portfolio, and the top five can't exceed 50%, so you generally need twelve or more stocks, or a diversified ETF that looks through to its holdings. Only liquid stocks and ETFs qualify, not bonds, crypto, options, mutual funds, or micro-caps.
Cost is the differentiator: Traditional exchange funds under Section 721 require accreditation, a seven-year hold, and fees around 1% to 1.5%. Faber's Section 351 launches carry a 0.25% expense ratio with no lockup, and cost basis carries over from the contributed positions.
A real opportunity for independent advisors: Over $20 billion has flowed into these structures in just a couple of years, with strong adoption among family offices. Many legacy incumbents can't or won't offer them, creating an opening for RIAs and individual investors.
It doesn't have to be all-or-nothing: Match the solution to the client's full situation. Younger clients in low brackets may prefer to harvest gains now, and partial moves often make more sense than wholesale diversification. As Faber jokes, the oldest capital-gains solution of all is a bear market.
Stick around to the end, where Faber discusses his new book, Investing in America: The Rise of a 250-Year Bull Market, out July 4th on Amazon and other major book retailers.
To learn more about Cambria Investment Management or connect with Meb Faber, visit www.cambriafunds.com.
Subscribe to Advisor Wars on YouTube, Apple Podcasts, and Spotify to catch every episode in this series on tax planning, including upcoming episodes on direct indexing and other tax-aware strategies for the mass affluent.
To learn more about Obsidian CIO or connect with Joe Halpern, visit www.obsidiancio.com.
IMPORTANT DISCLOSURE: Obsidian CIO LLC sponsors the podcast to further education and critical thinking about the factors that affect markets and investing. The podcast does not provide investment advice. Investment advice is offered only to clients of Obsidian CIO who have entered into an advisory agreement and with whom Obsidian CIO has identified individual objectives, risk tolerance, and other investment needs.
Show More
Show Less
Jun 24 202645 mins