Directional Hedge Funds: Many long-short equity hedge managers are not cognizant of the tax implications of their strategies. Generally, the managers that run a significant portion of their own taxable assets are more cognizant and tend to run more tax-efficient portfolios. This is an asset class where each manager needs to be evaluated individually as the after-tax performance will vary dramatically.
Private Equity: Private equity has long been one of the more tax-efficient asset classes as income is kept to a minimum and holding periods tend to be long, creating an asset that tends to produce mostly long-term capital gains. Private equity will become more attractive relative to other strategies that have exposure to short-term gains and income generation.

Real Estate: Real estate comes in many different structures-public vs. private, REITs vs. REOCs-and each has its own unique tax treatment. Starting in the public realm, REITs, which must pay out at least 90% of their net income, are taxed at regular income-tax rates since these are not considered qualified dividends. Conversely, REOCs, real estate operating companies, are not required to distribute their income and when they do it would be in tax-efficient qualified dividends. The tax efficiency of private real estate partnerships varies depending on their approach and structure, but they are generally more tax efficient than REITs.

Commodities: Investing in commodities through equities is a relatively efficient way to access the asset class. Investing in a fund that uses commodities futures (treated as 60% long-term and 40% short-term gains for tax purposes) typically is less tax efficient, depending on the underlying collateral held for the futures contract. Most hold either Treasurys or Treasury Inflation Protected Securities (TIPS), which are taxed at standard income tax rates. Some utilize municipal bonds, which are more tax favorable, but the decision hinges on whether the tax-equivalent yield is higher than Treasurys. Finally, the Exchange Traded Note (ETN) can be used where it is considered a prepaid forward contract and therefore is taxed based on maturity or time of sale. ETNs do not typically make distributions generated from underlying Treasury holdings and income generated is not taxed along the way. In fact, if the ETN is held more than a year, the net gain once sold is taxed at the long-term capital gains rate.

In the end, the key question is whether tax changes will affect your strategic asset allocation. While we seek to maximize after-tax returns for our investors, we don't anticipate making major changes to our long-term asset allocation strategies. Tax considerations will manifest themselves mostly through targeted manager selection, as well as sound estate planning and asset allocation. Finally, it is important to note that good investment decisions should always take precedence over tax considerations.

Ronald Albahary, CFA, is chief investment officer of Convergent Wealth Advisors.

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