Financial Engineering Practitioners Seminar: Leslie Abreo (in place of Andrew Kalotay)
Date: October 12, 2015 from 6:00 pm to 7:30 pm EDT
Location: Davis Auditorium, CEPSR Building
Contact: For further information regarding this event, please contact IEOR Department by sending email to info@ieor.columbia.edu .
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Title: Optimal Municipal Bond Portfolios for Dynamic Tax Management

Abstract: Municipal bonds are generally thought of as tax-efficient because the interest is tax-free. It is also recognized that tax-loss selling, combined with reinvesting in a like security, can improve performance over a buy-and-hold strategy. However, as currently practiced, tax-loss selling is typically an ad hoc year-end exercise, rather than a component of a dynamic tax management strategy. 

We consider a potential tax-beneficial trading opportunity as an option with quantifiable value, acquired automatically and without cost. Thus selling a bond and reinvesting in another bond also entails the exchange of the associated tax options. When we take into account the value of the tax option acquired upon reinvestment, the time to optimum execution of tax-driven sales is drastically reduced in comparison to one-time selling. 

Bonds purchased at a premium are far better candidates for tax management than those selling near par, because the price of a discount muni is adversely affected by the tax on the gain payable at maturity by a new buyer. Therefore the 'hold value' may exceed the market price by a wide margin, making the bond unsuitable for a tax-beneficial sale.

We quantify the expected excess return under dynamic tax management over buy-and-hold. Because of their greater price-volatility, long-duration portfolios naturally provide greater excess return. Performance also depends on investor-specific considerations, in particular the availability of short-term capital gains. In the case of a 10-year duration portfolio, under dynamic tax management the expected increase of annual return is 50 to 80 basis points.    

Bio: Andrew Kalotay is a leading authority on the valuation of municipal bonds. He is a prolific contributor to the literature on topics ranging from advance refunding to tax management.  His firm licenses fixed income valuation software and provides debt management advisory services. 

Before establishing Andrew Kalotay Associates in 1990, Dr. Kalotay was with Salomon Brothers. Prior to Wall Street, he was at Bell Laboratories and AT&T. On the academic side, he was the founding director of the graduate Financial Engineering program at Polytechnic University (now part of NYU). 

Dr. Kalotay holds a B.Sc. and M.Sc. from Queen's University and a Ph.D. from the University of Toronto, all in mathematics.  He was inducted into the Fixed Income Analyst Society's "Hall of Fame" in 1997.