Why Congressionally-mandated FIFO accounting will adversely impact your clients – and what you can do about it.

This past Saturday morning, the Senate passed their version of the Tax Cuts and Jobs Act bill. One of the lesser known provisions in the Senate bill, was the elimination of an investor’s choice to identify which shares of securities they may wish to sell or donate. The provision states that the only way securities may be disposed of is through use of an accounting method commonly referred to as First-in First-Out (FIFO) where the oldest shares purchased are the first ones an investor may sell. Because of the protracted appreciation of the securities market, the first shares purchased are likely to be the lowest cost and therefore carry the most gain (and resulting tax penalty).

The House version did not include this particular provision. And because there exists so many differences between both versions of the bills, this past Monday, Congressional Republicans went to a Conference Committee to begin reconciliation efforts on the various differences between the two tax bills. Led by House Ways and Means Committee Chairman Kevin Brady, and Senate Finance Committee Chairman Orrin Hatch, there are a number of hot topics that will need to be negotiated – including individual tax rates, the handling of AMT, child tax credits, corporate tax rates and repeals to the Affordable Care Act.

Because of the number of big-ticket and high visibility items included in the bill coupled with the pace the legislation is advancing, some experts fear that the FIFO provision may be overlooked and ultimately absorbed into the reconciled bill as collateral damage to bigger-picture negotiations.

However, we at Adhesion believe that this would be shortsighted as the provision is damaging to the very investors and savers that it is purports to protect. The provision has virtually no impact on the $1.7 trillion funding gap the bill creates as it is currently scored at generating just $2.4 billion over 10 years. As inconsequential as those revenues may sound they don’t even consider the expense side of the equation – no official estimates exist thus far on the offsetting expense associated with infrastructure retrofit needed to operate, report, comply and monitor the changes thrust upon the industry. And it certainly does not consider expenses associated with policing and adjudication of these matters.

Interestingly, the Investment Company Institute, the powerful lobby representing the mutual funds and ETF industry, were granted an 11th hour carve-out reprieve in the Senate bill to allow mutual funds and ETFs to continue to sell specific tax lots within their pooled investment vehicles. It is important to note this carve-out exemption for institutional investors does not extend to those retail investors purchasing and selling these instruments, only how the fund itself accounts for the gains and losses within their portfolios.

We feel there are some other anti-competitive and unwarranted elements in this provision that members of Congress, investment advisors and end-investors should be gravely concerned about. Specifically –

  • When the Senate proposed a carve-out provision that protected the institutional fund companies and ETF providers while ignoring the retail investor class, they created an uneven playing field that is heavily tilted against retail investors. Through this provision, the institutional investor will be afforded a significant advantage as they may exit any tax lot they wish. With the freedom to select tax lots, the institutional investors can sell at will, whereas the retail consumer will be locked-up due to tax costs associated with their low-basis FIFO shares. This sort of unfair playing field is analogous to suggesting institutional investors can trade commission-free yet retail investors must always pay commission. The provision creates an enormously unfair and artificial trading barrier that will heavily disadvantage retail investors.
  • With this barrier in place, end-investors will likely open up different brokerage accounts or have paper certificates issued to them. In both cases, there is no reasonable method to enforce or monitor for this type of behavior. This will drive up operational costs for advisors and custodians which will ultimately be passed through to the end investors. And by exploiting this loophole, the revenue projections for this provision are likely to fall even shorter than expected.
  • By adding friction to the retail investor’s ability to liquidate securities through a FIFO provision, one should assume that there will be less selling – which leads to less liquidity and efficiency in our capital markets. This also means that retail investors will be less inclined to eliminate assets in an attempt to seek diversification. This will ultimately lead to concentrated and highly appreciated holdings in client portfolios which runs in stark contrast to tried and true investment principles of diversification, rebalancing and buy-low/sell high for retail investors. This introduces the potential of an enormous loss during a market correction as well as introducing excessive levels of portfolio risk – all while stifling the efficiency of the capital markets.
  • This provision disproportionally burdens older investors who likely have a more extensive tax history and on average maintain a lower cost basis than younger investors. This FIFO tax also represents an unplanned expense that retirees had not budgeted for – which will erode retirement savings at a time when retirees have very little time to recoup this new, unanticipated retirement gap.
  • This provision also disproportionally disadvantages middle- and upper-income investors who are more likely to hold FIFO-eligible securities. Contrast that with ultra-high net worth and institutional investors who frequently hold real estate, hedge funds and other sheltered ‘accredited investor’ assets, which can be exempted from FIFO provisions as a result of the Senate’s proposed carve-out clauses.
  • Lastly, if legislation is advanced, one unintended consequence facing mutual funds and ETF providers is that retail investors will likely seek to avoid concentrated positions so as to have more choice on which shares to dispose of. Mutual funds and ETFs are pooled investment vehicles, and as such, they are generally far more concentrated in a client portfolio than individual equities. We believe advisors and investors will wisely consider diversifying out of concentrated mutual fund and ETF holdings into a larger basket of diversified equities so as to have multiple tax lots to sell. So rather than purchase Coke multiple times, an investor may consider purchasing Coke, Pepsi, Dr. Pepsi and Constellation Brands. Security prices and equity valuations may no longer be dictated based on rational, sound fundamentals, but rather from a desire to exploit loopholes in heavy-handed government legislation.

For a bill that is intended to promote simplification and fairness, we think it does just the opposite. It unfairly penalizes the retail investor with a FIFO tax while introducing liquidity friction and complicated recordkeeping. At the same time, it rewards the large institutional and ultra-high net worth investors with flexibility to use their own preferred inventory accounting methods. Most would argue that if framed properly and viewed in its totality it would be difficult to defend.

So what can you do? We think this particular provision just needs a bit of sunlight so that it can be evaluated and debated in the open. With enough voices we think we can make this happen and we encourage you to get involved.

First off, encourage your clients to take action.  Consider directing them to TD Ameritrade’s Legislative Action Committee site, which has done a fantastic job of highlighting the issue.  From this site, they may contact their local representatives .

Next, as investment fiduciaries we would urge you to read the Money Management Institute’s position on the Senate version of the tax reform legislation.  On their site, the MMI chairman, Craig Pfeiffer shares talking points and a number of template letters you can use to contact your elected officials.  Similarly, the Investment Advisor Institute – an advocacy group for SEC-registered investment advisory firms has developed a site to contact elected officials and communicate your concerns of FIFO legislation.  Adhesion has also drafted an open letter to Congress which can be found here.  Feel free to use it or modify it and share it with your elected officials.

Also, as we head into year end, consider generating losses through active tax harvesting.  These losses can be used to unwind concentrated mutual fund or ETF holdings or buffer against future taxable gains resulting from potential inflexibility associated with this bill.  For more information on the value of tax harvesting and how it can add value to a client portfolio, feel free to watch this webinar

Lastly, we think now is a good time to dump concentrated mutual fund and ETF holdings to spread those proceeds into a diversified pool of equity holdings.  If you are interested in active equity managers, please consider Adhesion’s Asset Manager eXchange which can be found here.

Share Button

Adhesion Wealth Advisor Solutions & Auour Investments: Evolution of Downside Protection Webcast

auour-investments-sqEach month, strategists on the Adhesion platform offer insights on market trends and their products. We invited Auour Investments, to kick-off the Adhesion Manager Webinar Series.

To check out the recording of the Auour presentation, click HERE.

Visit the Adhesion eXchange to view Auour marketing material, performance data and much more.

About the Webinar:

Is Downside Protection on your Mind?

Downturns happen and the most recent have been some of the worst. With the current bull market in its eighth year and geopolitical risks creeping up, it may be time to think about the various strategies used to protect against material losses. This webinar will discuss the evolution in protecting against market draw-downs and the recent advances made using Regime-Based Investing.

Investing to the Regime with Regime-Based Investing

Regime-Based Investing is a new investment approach that dynamically adjusts market exposures throughout a changing investment environment. By adapting to the changing investment landscape, investors are offered a new strategy to minimize market downturns without the need to sacrifice performance in rising markets.

About Auour:

Auour is an ETF-based strategist that has been an innovator in Regime-Based Investing with five strategies that span the risk spectrum.  Robert Kuftinec  and Joe Hosler are two of the three founders of the firm and with their third partner bring over 65 years of combined investment experience and managing over $8Bil in assets at various major investment firms.

The Auour investment strategies are dynamic/tactical investment portfolios for both equity and fixed income needs.  The funds use ETF’s, which are low cost and tax efficient compared to mutual funds.

  • Fully Participate when markets grow – Auour’s algorithms also look to increase the aggressiveness if the market is constructive, allowing for the opportunity to outperform. Auour will change the investments to those that are intrinsically under-valued compared to others striving for better-than-market returns.  There are times when certain asset classes should work better than others, Auour’s models look to find those.
  • What makes Auour different? – The approach to downside protection is very analytic as the algorithms rigorously measure market risk and market movements.  The proprietary algorithms measure enormous amount of data every day to predict the risk in the market in their attempt to move to cash before material downside hits the markets.
  • In short, the Auour portfolios aim to participate in rising markets while experiencing less of the downturns when the markets are soft and can be customized to each client’s particular risk tolerance.
Share Button

Why Goals-based is not code-word for ‘ignore performance’.

There is a lot of confusion about what it means to deliver and receive a goals-based investment solution.  Most retail investors believe ‘goals-based’ is simply another attempt at dismissing under-performance.  Or at least so says a recent study cited by Wealthmanagement.com.  In the article, the study indicates that clients believe that “Goals-Based” equates to Performance.  We think it means much, much more.

Part of that disconnect can be attributed to our track record as an industry of wrapping otherwise straightforward ideas in jargon and arcane statistics.  Perhaps another cause of confusion is that many advisors simply do not have the wherewithal to architect, deploy, support and maintain a true goals-based framework.  At Adhesion, as we spoke with our advisory clients, we quickly came to realize that their clients were asking for investment solutions that not only identified where they were on their path to their goals, but also adjusted based on how they progressed on their objective.  We found that many so-called Goals-Based programs that were out there were largely theoretical and academic in nature – making them, at best  – unimplementable by most advisory firms.  We also found that many programs – in addition to missing the upfront and ongoing diagnostics of the client to their goal –did not take into consideration real-life factors like taxes, expenses, downside protection and real-life spending rates.  And for those that did, the cost and accessibility of the program was often prohibitive.

So we are excited to introduce Pathway Portfolios   The suite is comprised of 13 Unique Core/Satellite Portfolios – blending both active and passive investment styles across the three investor lifecycle phases – the Gain Phase, The Protect Phase and the Spending Phase.  The strategies have been built to address the unique challenges associated with each phase of an investors lifecycle:  The Gain Portfolios are designed for investors who are earlier in the investment lifecycle and looking to maximize capital appreciation through a globally diversified portfolio, but while staying within their risk appetite.  The Protect Portfolios are for those investors who are closing in on their goals and looking to achieve some level of capital appreciation yet limit downside exposure, which can be devastating for those approaching retirement (see 2008-2009).  And finally the Spend Portfolios are designed for those who have achieved their goals and looking to accomplish a target spending rate while simultaneously maximizing investment longevity.

The program leverages investment products from a combination of separate account managers, actively managed mutual funds, and passive ETFs and have been engineered to fully leverage the sophisticated Adhesion Unified Managed Account (UMA) platform.

We are excited to share them with Adhesion advisors who custody assets at TD Ameritrade, Schwab Institutional and Fidelity.  Please visit gotopathway.com to find out more.

Share Button

Around the RIA Web with Adhesion, July 2016

A few great reads from the month of July, highlighting some of the key conversations we’re having with advisors. Growth, technology, investment design, outsourcing, recruiting, compliance…all are key discussion points for RIA firms and we share the following for your own discussions:

Michael Kitces on the benefits of taking a smaller piece of a larger pie, with thoughts to consider before taking on another advisor’s practice.

How does one benchmark for alternative strategies like momentum and trend-following? No perfect answer, but David Varadi makes the case for an appropriate way to account for the different risk profile of tactical.

Millennials love the RIA model, and TD Ameritrade is embracing graduates of financial planning programs.

Not surprisingly, the latest Jefferson National Adviser Authority study shows growth-oriented advisors embrace technology at a far great rate than their peers.

Advicent with thoughts on 16 questions to consider in turning your practice into a business.

The SEC is putting broker-dealers on alert for expanded disclosure of order handling. HedgeCo highlights some of the proposed details to be shared on a monthly and quarterly basis.

Rather than plan for specific goals, Michael Kitces explains how much our goals may change and why it may make more sense to simply plan for a flexible future.

Advisor marketing should go beyond just getting the word out. The Journal of Financial Planning shares thoughts from leading financial services marketers on designing a true program for growth.

Growth at RIA firms continues across all sizes, with larger firms continuing to become more productive and profitable. The latest Schwab benchmarking study summarized here.

JP Morgan guide to the markets is always chock full of interesting visualizations.

Adhesion continues to work behind the scenes in helping advisors grow, with new options allowing the integration of Outsourced CIO implementation via Mercer and robo technology via Riskalyze. We welcome your feedback at solutions@adhesionwealth.com, and encourage you to subscribe on the upper right of this page to receive our regular blog updates.

Share Button

Around the RIA Web with Adhesion, June 2016

A few great reads from the month of June, highlighting some of the key conversations we’re having with advisors. Growth, technology, investment design, outsourcing, recruiting, compliance…all are key discussion points for RIA firms and we share the following for your own discussions:

Wealth Management writes that the SEC proposal on succession planning is officially out, requiring RIAs to explicitly adopt and implement business continuity and transition plans. For those who have yet to adopt formal policies, the cost of implementation may be substantial and accelerate the trend towards multi-advisor platforms.

The clear trend in ETFs is towards lower fees, but massive amounts of money still reside in higher-fee counterparts. As shown by ETF.com, the march will continue at its own pace with RIAs and ETF strategists the typical early adopters of lower-fee products.

EVERYONE is in the market to buy existing advisory firms. Michael Kitces shares some ideas on (too?) popular ways to find opportunities, as well some less-traveled paths and key considerations in an acquisition.

Common theme for successful outsourcing…find a strategic partner not just a product vendor. How two advisors leverage healthy relationships, via Financial Planning magazine.

The standard 60/40 portfolio has been a tough benchmark in recent years, but basic math says that will be a tough act to follow. Illustrations from EconomPic and Charles Sizemore reveal a need to blend in some alternatives going forward.

Happy clients generally means happy advisors. Julie Littlechild suggests some steps for a manageable 7 week bootcamp to deeper client engagement.

Servicing clients of all sizes is a constant battle between the hearts and minds of advisors. There is no doubt that the DOL rule will force firms to reconsider how and whether they service smaller accounts. Our clients have been on this issue long before the DOL ruling, prompting ETF Select to be included as a new investment option for Adhesion client firms.

Retail investors are often mocked as “dumb money”, but behavioral biases are just as likely to impact those human beings known as advisors. Abnormal Returns shares thoughts on how hindsight bias can creep into all of us, and how the habit of writing can be an outlet for clear planning. Michael Batnick does his part to write about hindsight bias as well, and how some market truths are merely traps.

Reverse churning is a serious issue, and Blaine Aikin thinks the new DOL fiduciary rule puts more bite into the ability for regulators to demand more documentation from firms transitioning IRAs.

As Ben Carlson shares, what a firm DOES NOT do can reveal just as much as what they do. This negative knowledge can act as a worthy qualitative filter in assessing investment managers. Pair that with this riff from Tom Brakke on man vs. machines and you’re ahead of most highly-paid investment committees.

In this world of more sophisticated number crunching, let’s not forget that market “risk” is not truly quantifiable. It is not those with the best formulas who deliver the best plans, but Phil Edwards of Mercer suggests an open and imaginative mind towards the uncertainty of the future.

Client acquisition is a real but hard-to-quantify cost for advisors. Michael Kitces had two comprehensive articles on low-cost and high-cost ways to grow one’s client base.

The active vs. passive debate is never-ending but thoughtful advisors can look with an objective lens at the merits of both sides. As Nir Kaissar shows, the S&P 500 as it currently stands is currently structured as a bet on high valuation-stocks.

There is constant competition for the attention of affluent investors. Are there aspects of your practice that are highly unique to your firm? Matt Oechsli shares 13 true differentiators for financial advisors.

No such thing as a perfect portfolio but a core/satellite approach can provide an ideal mix of cost, reward/risk, and client behavior. Deborah Fox shares some thoughts on logical blends.

Interesting insights from the Schwab Independent Advisor Outlook Study into the way different RIA firms see their business changing over the next few years.

Adhesion continues to work behind the scenes in helping advisors grow, with new options allowing the integration of Outsourced CIO implementation via Mercer and robo technology via Riskalyze. We welcome your feedback at solutions@adhesionwealth.com, and encourage you to subscribe on the upper right of this page to receive our regular blog updates.

Share Button

Around the RIA Web with Adhesion, May 2016

A few great reads from the month of May, highlighting some of the key conversations we’re having with advisors. Growth, technology, investment design, outsourcing, recruiting, compliance…all are key discussion points for RIA firms and we share the following for your own discussions:

How does an RIA differentiate in a world full of “advisors”. By casting a tighter net, NOT a wider one. A must read from Michael Kitces on connecting with one prospect vs. trying to appeal to all of them.

We all want to embrace technology in the name of “efficiency”. Smart adopters take the time to think through the larger opportunity of better allocation of resources, and the right path to getting there. HarvardBiz with a great article on the flexibility, new learning opportunities, and advancement prospects that are possible with the right human/tech combo.

Banking on expected returns carries its own risks, but the danger gets magnified when future liabilities force inappropriate investment choices. The Thought Factory eloquently explains this risk, and Ben Carlson further clarifies what can happen when aggressive assumptions take the place of hard choices.

Adding to the risks highlighted above, how can future return assumptions remain so high after an unprecedented period of fixed income returns? Wes Gray shows the historically high returns in the recent past, while Brian Portnoy highlights the risks of plugging into cheap fixed income ETFs after a multi-decade bull market.

Speaking of risk, what is it? Risk can explained in a number of ways, depending on which pundit or academic is speaking. David Merkel shares a few ideas about properly defining risk, relevant to most clients of advisors.

Josh Brown makes a compelling case for rejecting clients who want it their way. In other words, suggestions are not as valuable as advice, and neither party benefits from this type of “customized” solution. Might be a good way to get out in front of the too many clients problem.

Formal schooling is just the ante for a career in financial services. Real client-facing experience is a must in learning to deal with demanding and anxious customers on a frequent basis, as shared by Lawrence Hamtil.

Factor funds are all the rage but are not created equal. As shown by Jack Vogel, the number of holdings, weight of those holdings, and reconstitution of those holdings varies and can lead to dramatically different outcomes.

It’s always good to hear how industry peers think about running their business. A few observations in Financial Planning on enhancing the human aspects of fee-based, fiduciary advice.

Adhesion continues to work behind the scenes in helping advisors grow, with new options allowing the integration of Outsourced CIO implementation via Mercer and robo technology via Riskalyze. We welcome your feedback at solutions@adhesionwealth.com, and encourage you to subscribe on the upper right of this page to receive our regular blog updates.

Share Button

Around the RIA Web with Adhesion, April 2016

A few great reads from the month of April, highlighting some of the key conversations we’re having with advisors. Growth, technology, investment design, outsourcing, recruiting, compliance…all are key discussion points for RIA firms and we share the following for your own discussions:

Tim Harford on the compromise effect and the paradox of choice, relevant for how advisors choose investments and their clients choose an advisor.

Michael Kitces uses the context of diet and exercise to show how advisors can use small financial planning goals to help clients on a successful long-term journey. More excellence from Michael on the evolving skill set of the modern advisor.

Ben Carlson on building failure into your process, so important in developing robust investment plans. This pairs well with his post on the dual mandate of an investment advisor, that the best plan for a client is one that survives the real world.

Tom Brakke states well the obvious flaw in starting manager research with a performance screen, and Corey Hoffstein shares the additional problems with using 3 years as a lookback period. The team at GestaltU covers the perils of past performance quite well in this excerpt from its new book.

A great advisor views his/her role as one of deep relationships, personal advice, and ongoing coaching through the journey. Awesomeness from Josh Brown on The Job Security of a Great Advisor.

Our advisor clients tend to embrace the flexibility of an open-architecture platform, again demonstrated in our approach to “robo”.  Some providers have chosen a more bundled approach to advisor solutions, later requiring a messy divorce in trying to replace any specific component.

Are you marketing to a niche market, or truly serving one? Julie Littlechild neatly explains the difference.

When it comes to data, more is not always better. As Tadas Viskanta explains, comparing different eras is hard and in investing can be downright dangerous.

Josh Brown on how bad active management is being taking to task. Jake at EconomPic shows when good active management can be worth the cost. Patrick O’Shaughnessy rounds out this topic with a wonderful illustration of the difference between seeking alpha and seeking assets.

Speaking of expensive active management, ThinkAdvisor reports that the SEC is prepping a 2016 initiative on 12b-1 fees, a hidden cost of mutual funds that gets disclosed but rarely discussed.

One trend sure to continue with the new regulations is mergers and acquisitions of RIA firms. Investment News summarizes this trend, and shares good ideas on items to consider in any potential arrangements.

Speaking of new regulations, some solid advice from Russell Investments on creating, documenting, and reviewing best practices for healthy client relationships.

The consummate guide to the DOL ruling from Michael Kitces, incredibly thoughtful and no stone unturned.

JP Morgan puts out a wonderful Guide to the Markets every spring, with all kinds of fun and informative graphics.

Adhesion continues to work behind the scenes in helping advisors grow, with new options allowing the integration of Outsourced CIO implementation via Mercer and robo technology via Riskalyze. We welcome your feedback at solutions@adhesionwealth.com, and encourage you to subscribe on the upper right of this page to receive our regular blog updates.

Share Button

Around the RIA Web with Adhesion, March Edition

A few great reads from the month of March, highlighting some of the key conversations we’re having with advisors. Growth, technology, investment design, outsourcing, recruiting, compliance…all are key discussion points for RIA firms and we share the following for your own discussions:

We had a host of DOL-related articles prepping for the forthcoming proposal, but now that it’s here it makes more sense to replace the March speculation with April reality. Summaries from Investment News and Wealth Management look to be the best so far, with revisions sure to spark both relief and disappointment on all sides. This nifty graphic from the DOL outlines the changes from the original proposal to the final edition.

Clear communication is a key part of attracting clients to any service business, but most of us fall short of the “clear” part. Farnam Street summarizes the latest from Steven Pinker into some key tips on better writing.

Newfound Research on ETF apples and oranges, cost matters but it’s equally important to understand what lies under the hood.

Cybersecurity is not only smart business for an RIA, but an issue now being monitored by the SEC. TDA4Advisors on keeping your firm safe from a security breach.

Most of our dealings are with growth-oriented firms, as a Unified Managed Account(UMA) platform provides a wonderful solution for integrating new business. As shown by Schwab Advisor Services, acquisitions are occurring at an unprecedented pace.

The value of a good advisor cannot be overstated. Sheryl Rowling shares how deeper relationships are at the heart of mutually beneficial holistic planning.

Speaking of holistic planning, investors are often caught using the wrong yardstick for performance. Ben Carlson shares some common sense ideas on more appropriate benchmarking.

Interesting look at the inadvertent launch, and near failure, of the ETF industry. From a possible remedy for market volatility, to a starring role in triggering volatility, this excerpt from Eric Balchunas reveals a fascinating tale of incentives and unintended consequences.

“When a measure becomes a target, it ceases to be a good measure.” Thought-provoking piece on the impact of index investing via Patrick O’Shaughnessy.

Tadas Viskanta even gives us an outlet when away. One of his questions to bloggers confirms that no one likes the term “smart beta”, but does anyone like the concept? Here are three good reads on the subject, from Michael Batnick to Benjamin Lavine to Wes Gray. And frankly, the whole Abnormal Returns series from that week will provoke thought amongst advisors.

A unique way to view asset allocation methodologies via Mark Rzepczynski, if your advice goes beyond Modern Portfolio Theory it makes sense to define and communicate how that advice differs from others.

40 of the Most Important Charts in the World via Business Insider, some more useful than others but certain to fit just about any Wall Street media narrative.

Adhesion continues to work behind the scenes in helping advisors grow, with new options allowing the integration of Outsourced CIO implementation via Mercer and robo technology via Riskalyze. We welcome your feedback at solutions@adhesionwealth.com, and encourage you to subscribe on the upper right of this page to receive our regular blog updates.

Share Button