Tag Archives: Wealth Management

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.

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Rep as PM is Not Without Risks in 2015

In the Fidelity Advisor Investment Pulse Survey almost a third of advisors cited portfolio management as an area of focus during the first quarter of 2015. This was a marked increase from 18% in the fourth quarter of 2014.


Source: Fidelity Advisor Investment Pulse Survey

Scott Couto, President of Fidelity Financial Advisor Solutions, stated in a recent WealthManagement.com article that in the current climate increasing numbers of advisors are taking discretion over their client portfolios. A WealthManagement.com survey reported that 54% of advisors said they have used rep as portfolio manager platforms for the past five years, managing investment portfolios across client accounts.   This can come with its own set of problems, however. Couto points to situations where advisors must defend their portfolio allocation when clients ask why their portfolio didn’t match the S&P 500 at the beginning of 2015. Add to this the increasing concern over market volatility, especially in regards to international investing. 11% of advisors cited international investing as a concern; up from 5% in the previous quarter.

Opportunities abound, but advisors shouldn’t automatically assume that they can capitalize all on their own. Many top advisors are maximizing their “rep as PM” value prop by outsourcing to a customized UMA platform like Adhesion. This enables them to offer unified household reporting and a range of investment types and managers as they see fit. Many others are finding that they offer more value to their clients when they outsource the CIO function.

Adhesion offers an outstanding team of managers and strategists that we call our Unified Managed Program (UMAP). These leading strategists offer asset allocation, manager & vehicle selection (SMAs, MFs, ETFs) with on-going due diligence documentation. Click here to learn more about Adhesion’s UMAP. This “fully defensible” approach lets advisors maintain discretion while leveraging best in class investment expertise. With Adhesion advisors choose the level of outsourcing they want and designate the experts and resources to carry it out. This gives them the ability to focus more time and energy on client relationships and bringing in new business.

Click here to learn more about Adhesion’s outsourcing options.

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5 Things The Robos Can Teach Us

Heading into 2015, the threat of “robo-advisors” will continue to be a hot topic within the industry.  A January 14th article by WealthManagement.com, “The Ultimate Robo Defense Plan,” makes the case that the best defense is a good offense.  In other words, what can we learn from the things Robos cannot do?  Here are 5 ways to put this into practice:

1. Conduct a Wealth Management Services Audit

Research tells us that today’s affluent investor wants a primary financial advisor to oversee the different aspects of their family’s finances.  With that in mind, RIAs should determine whether they are providing these kinds of comprehensive wealth management services to their affluent clients.  If yes, the next step is to be sure your clients are aware that you are in fact providing these services.  As the article states, “Everything counts; from coordinating with outside experts such as estate attorneys, bankers, CPAs and the like, including the children, organizing and helping keep all their (not just your) family’s financial documents current, to making certain their financial plan is current and being followed.”

2. Assess Client Relationship Strength

As the article makes clear, today’s affluent client wants more than just the standard service model.  Research shows that affluent clients want a relationship with their advisor that combines business and social.  RIAs need to be keeping track of their personal, non-business client interactions.  How frequent are they?  Do they include both spouses?  Are you aware of family details like names of children?  Here’s an important statistic to keep in mind: while almost 80% of advisors reported that they had both a business and social relationship with their affluent clients, only 29% of the affluent clients saw the relationship that way.

3. Conduct a Transformative Business Meeting

This is crucial.  The idea is to set a meeting that transforms your relationship in the mind of the client “from that of a broker who handles their investments, to their family’s primary financial advisor who oversees the totality of their financial affairs.”  As the article points out, the deeper your understanding of an affluent family’s needs and wants beyond those that are investment related, the more they will trust and respect you.

4. Get Social

The article suggests that the conclusion of your transformative business meeting is the perfect time to suggest you and the client get together socially.  Do your homework and discover what your client is passionate about.  Knowing these personal details is what will allow you to “surprise and delight” your clients in the future.

5. Create a Client Relationship Calendar

This step is about giving your client relationship strategy a framework going forward.  In other words, “put structure around the social relationship you’re developing with affluent clients in the same manner you take with your quarterly reviews and monthly touch-base calls.”  The more emotional and social touch points you generate with your clients, the stronger the relationship will be.  And that’s really the take-away here: the stronger the relationship, the stronger your Robo defense.

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