By Bruce W. Fraser
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 Inc.'s seven-year capital markets forecast at a press briefing yesterday in New York this week. 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, 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 analyzed returns in the 6.2-7.7% 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 "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 post financial crisis there has been a fundamental shift in clients' focus toward risk management and preservation of capital, and accepting 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 due to their risk adverse behavior.

One of Gore's clients, discussing his risk and duration parameters, said his maximum maturity should be only 60 days. "Obviously," said Gore, "this doesn't give us much to work with, but the point of the story is there is continuing volatility and principal risk, and to best help the client requires continuing education on the markets, interest rate sensitivity analysis, and risk/return trade-offs."

Gore also said that, in contrast to 2011, the firm is seeing more activity in the planning area, with clients executing plans through gifting strategies, setting up Delaware Dynasty Trusts, and reviewing estate plans.
Kroch explored proposals affecting income, tax, estate and gift planning. She said much uncertainty surrounds current tax planning, making concrete planning difficult. 

The Tax Act of 2010, she said, created enormous opportunities for high-net-worth families to transfer wealth through 2012, and she urged wealth managers to take positive action before the window  closes for many of them on Jan. 1, 2013, unless Congress acts.

Single individuals, for example, may now transfer up to $5 million free of gift and generation skipping transfer (GST) tax, and couples up to $10 million. The 2010 Act also provides a $5 million estate tax exemption and a 35% estate tax rate through 2012. Using the increased exemptions to fund a trust, particularly a Delaware Dynasty Trust, can also be a great way to benefit future generations, she said. But unless Congress acts, in 2013, all three taxes increase to the highest rate of 55% and drop to a $1 million exemption, Kroch warned.

Kroch touched on some contingencies affecting federal estate, gift and GST proposals. Among them are proposals to limit the GST exemption to 90 years; require a 10-year term for grantor annuity trusts (GRATs), and a remainder greater than $0 and prohibit decreasing annuity payments; to modify rules on valuation discounts for family-controlled entities; make permanent portability rules, and require consistency in value for transfer and income tax purposes.

Income tax proposals pending include rules to limit the value of itemized deductions; from the highest scheduled tax rate of 39.6% next year to 28% for taxpayers in higher tax brackets, and extend the Bush tax cuts, except for high income taxpayers, and proposals to tax capital gains and dividends of high income taxpayers at 20%.

Kroch also noted long-term benefits for a family of the Delaware Dynasty Trust, an irrevocable trust designed to stay in effect for multiple generations. The gift tax benefit is enhanced by the fact that most states do not impose gift tax, she said. Another alluring feature is its portability, meaning the unused estate tax exemption of a decreased spouse is portable for gift tax purposes for 2011 and 2012 only.