Wilmington Offers Sobering Economic View
Wilmington Trust gave a sobering assessment of the U.S. economy and in particular investment-grade bonds, whose stability has been comforting to investors lately.

Rex Macey, chief investment officer of Wilmington Trust Investment Advisors Inc., said, "The concept of 'safe' assets and 'risky' assets can be misleading. Rising interest rates will offset the increased income, leaving investors and investment-grade bonds with little or no return after inflation."

Macey outlined the findings from Wilmington Trust Investment Advisors' seven-year capital markets forecast at a press briefing in New York last month. WTIA is the investment management arm of the trust firm, based in Wilmington, Del.

Other speakers included Lawrence E. Gore, president and managing director of Wilmington Trust's New York office, and Carol G. Kroch, head of wealth and financial planning and managing director of charitable trusts. Roger W.  Hobby, president of the Northeast region of Wilmington Trust, served as moderator.

Macey said the U.S. economic recovery remains fragile. "The financial crisis has damaged financial institutions, credit is tighter, and the consumer is deleveraging," he said.

WTIA's capital markets forecast of 2012-2018 anticipates annual returns of roughly 2.0% on investment-grade bonds, both taxable and tax-exempt, way below what investors have earned on these bonds recently. Wilmington Trust expects U.S. inflation to remain contained, averaging 2.3% during this period.

He said Wilmington favors bonds that offer higher spreads for credit risk-floating-rate notes, high-yield corporates and emerging market debt. "We're looking for yields where you don't have to take on additional duration," he said.
These bonds are forecast to deliver annualized returns in the 6.2% to 7.7% range. The group also favors large-cap U.S. stocks, with expected annualized returns of 8.5%, small- and mid-cap stocks with expected returns of 7.7% to 9%, and developed international stocks in markets like Europe and Japan, which are expected to achieve higher returns than domestic stocks.

"Investors have shunned them so much that they are attractively priced relative to domestic stocks," Macey said.
Wilmington Trust also favors commodities and global natural resource investments "as hedges against unexpected inflation," according to Macey.

In the shorter term, "current optimism in the market is fragile," Macey said. "2012 may resemble 2011 in that investors will be disappointed after a good start."

Gore said that since the financial crisis there has been a fundamental shift in clients' focus toward risk management and preservation of capital, and they accept more modest growth within their portfolios.

"On the investment side, we rarely have discussions these days that focus on returns left over from the pre-crisis markets. In other words, can't I get 10%, 12%, etc.?" Gore said. "The discussions are more focused on concerns around volatility, mitigation of risk, and portfolio preservation against downward spikes in the market."

Another trend, he said, is that clients are now much more aggressive in providing information so they can best review and enhance their strategy and make intelligent decisions. Although many clients seek higher yields on their investments, some are still on the sidelines, shunning risk.
-Bruce W. Fraser

Carried-Interest Tax Increase Proposed
(Bloomberg News) Representative Sander Levin has outlined a new proposal in his five-year effort to increase the tax rate that private equity managers and other investment executives pay on their so-called carried interest earnings.
The bill by the Michigan Democrat is similar to a proposal in President Barack Obama's fiscal 2013 budget. The administration estimates the change would generate $13.5 billion in additional taxes over the next decade.

"This loophole for years has unfairly enabled some of the highest-paid individuals in the country to sharply reduce their tax bills and it is time to close it once and for all," said Levin, the top Democrat on the House Ways and Means Committee, in a statement.

Republicans object to the tax change, saying it would hurt economic growth. The House passed Levin's proposal when Democrats controlled the chamber. It hasn't advanced since Republicans took control of the House after the 2010 election.

Private equity managers are paid management fees and carried interest, which typically is a 20% share of the profits earned by their funds. The management fees are taxed as ordinary income, which has a top rate of 35%, and carried interest is considered a capital gain taxed at a top rate of 15%.