The third quarter’s market downturn presented an opportunity to reduce our clients’ tax burden using “tax-loss harvesting” and add a name to our portfolios at relatively low cost. Earlier in the quarter we also pared several of our largest positions and sold out of two others.

Tax-loss harvesting means that we sold several stocks that fell in value from their cost bases. Realizing those losses makes them tax-deductible, which can be particularly beneficial in a year like this one, because despite the recent market decline, clients are still likely to have taxable net gains for the year. After a 30-day waiting period required by the IRS to claim the loss, we are then able to buy those stocks back, ideally for a net benefit, including tax savings and trading fees. Ultimately, we intend to recreate most positions that clients held before selling.

We hedge market risk over that 30-day period by adding to some stock positions that have losses, selling the others, and doing the opposite a month later. We began the process by selling our entire position in W.W. Grainger (tkr: GWW) and doubling positions in Michael Kors (tkr: KORS) (see Featured Equity) and Whole Foods Market (tkr: WFM). After the 30-day waiting period, we will sell our long-term positions in Kors and Whole Foods. We might also elect to buy back Grainger pending our review of its business. By executing the initial transactions when we did, this strategy also avoids the risk of volatility due to earnings releases.

If potential tax-loss deductions are larger than the government’s annual limit, clients can reduce their cumulative tax burden by carrying over “unused” net losses. This was a common practice after the financial crisis; it was several years before many clients had to pay substantial capital gains taxes again. (If you have questions about the mechanics of these transactions please give us a call at your convenience.)

Early in the quarter, we trimmed our investment in Amazon.com (tkr: AMZN) to 3.5% of the portfolio. It had grown to 4.8%, large enough that we thought it prudent to lock in some of the gains earned so far this year. Our conviction that oil prices will remain low long-term increased as OPEC continued to grow output above its target, leading us to sell our position in Hess (tkr: HES). Unlike our other oil producers ExxonMobil (tkr: XOM) and Chevron (tkr: CVX), Hess’ cash flows are not hedged by refining operations, it pays only a small dividend that does little to compensate for sector volatility, and it has a relatively limited array of assets that it can sell to raise cash. We also sold TopBuild (tkr: BLD), a business spun out from Masco (tkr: MAS) during the quarter, to focus our exposure on Masco’s businesses that derive most revenues from repairs and remodeling. We took advantage of the market dip to buy a 1.5% position in Illumina (tkr: ILMN). Illumina is the undisputed leader in genetic sequencing instruments, and we think its knack for developing winning technologies and its first-rate execution portend strong long-term growth.

Individual investment positions detailed in this post should not be construed as a recommendation to purchase or sell the security. Past performance is not necessarily a guide to future performance. There are risks involved in investing, including possible loss of principal. This information is provided for informational purposes only and does not constitute a recommendation for any investment strategy, security or product described herein. Employees and/or owners of Nelson Roberts Investment Advisors, LLC may have a position securities mentioned in this post. Please contact us for a complete list of portfolio holdings. For additional information please contact us at 650-322-4000.