Investor faith in active stock managers’ ability to generate alpha, or value add, has been exhausted.  Years of disappointment with high costs and poor relative returns have given way to disillusionment and distrust. According to Morningstar research only 14 percent of active large cap blend fund managers successfully outperformed their passive rivals over the past decade (through 2016). The recent period of Fed fixated, low volatility, one way markets has likely damaged active management results, frustrating clients and their advisors while inspiring a “what have you done for me lately” mindset. This lack of confidence in active management has driven investors to passive strategies in ever greater numbers.  According to Bernstein, the high-net-worth asset manager, passive equity investment management will equal active for the first time ever in early 2018.

We believe that active manager relative outperformance will recover as years of extraordinarily easy monetary policy are reversed and the stock market rally of past eight years fades away. Unlike cap-weighted index funds, active investment managers alter allocations as markets conditions dictate—for example, raising cash and emphasizing defensive stocks in bear markets. Further, market dependence upon Fed monetary policy (QE) caused large cap stocks to correlate highly over the past several years.  As the policy is unwound we believe lower correlations (a condition necessary for effective stock picking) will follow. In the meantime, there is one area of investment management where significant investor alpha continues to be available—tax-loss harvesting (TLH). TLH is a proven method of adding value to client portfolios on an after-tax basis, and an especially important contribution to retiree portfolios. Without TLH and a commitment to realized gain budget planning, retirees may be compromised by unexpected and unnecessary taxes.

Through the use of separately managed accounts (SMAs) in taxable portfolios each security can be traded independently. Advisors can opportunistically harvest each security within a client’s portfolio (unlike with mutual funds and ETFs where each purchase and sale is representative of all securities). SMA holders can benefit greatly from security specific evaluation. The use of highest-in first-out (HIFO) stock position inventory accounting ensures the best possible tax result by first applying the higher cost share blocks of each security. A study published by Parametric Portfolio Associates found that TLH within structured index-like portfolios could improve annual after-tax returns by as much as 2 percent in low return markets and 1.5 percent in normal markets (over a ten-year period). And unlike most other advisory/asset management activities, tax-loss harvesting opportunities usually increase during periods of high market volatility and (or) challenged markets.   

Let’s take a moment to review the process of TLH in client portfolios. When purchased securities fall below their original purchase price (or basis) they may be sold as a way of realizing losses to offset realized gains elsewhere in portfolio. Short-term losses (those held for less than one year) can be used to offset short-term gains while long-term losses (you guessed it, held for greater than one year) offset long-term gains. The maximum tax rate on short-term gains is identical to ordinary income (at 39.6 percent) while the long-term gains tax is half that (at 20 percent). Thus a short term realized loss is worth about twice what the long term variety provides though bear in mind that when portfolios lack long-term losses, the more valuable short term type must be applied to offset realized long-term gains.  

First « 1 2 » Next