Lee kicked off the session by outlining a cliché he sees in the wealth management business: that “it's not what you make, but what you keep.” In his experience working with high net worth investors, “a lot of times they segregate in their minds tax efficiency from investment management efficiency,” he said. “That is a big mistake; I think you need to think about it holistically.”

Lee's first question to the panel was aimed at Silverthorne of Evercore, who was asked to highlight current techniques being used in the industry for maximizing after-tax portfolio returns.

“The whole subject of taxes and investing...is a good example in my mind of our industry in terms of cognitive dissonance,” Silverthorne said. “A lot of us know we should pay attention to it, but what actually happens seems to be dramatically different.” He noted several reasons for this: the subject itself is complicated, portfolio manager incentive plans are all based on pre-tax returns, and the modeling analytics used in the industry are based on pre-tax assumptions. 

Besides municipal bonds , prevalent techniques include passive strategies such as exchanged-traded funds , mutual funds and passive tax lost harvesting strategies, as well as asset location .

Another concept, “core and explore,” might involve setting up a passive tax loss harvesting core strategy, and surrounding that with other active strategies, he said. “Or with a multi-manager approach, these days we have the technology available to put many different active SMA managers into an omnibus account and implement a tax loss harvesting overlay.”

Legislation

Moving over to the legislative environment, Lee turned to Riggs of O'Connor Davies, noting that tax rate hikes over the last several years came as no surprise to many investors.

“I can sum up the tax picture in three or four words,” Riggs said: “Taxes are going up.” Riggs went on to highlight some of the points covered in the 2015 “Green Book,” which is essentially a “wish list” for the US Administration with respect to revenue raising and taxation, and what is anticipated by way of legislation going forward.

“The Green Book is fairly aggressive this year, and is something people do look at in the industry to get a sense of where things are heading,” he said.

Among this year's highlights is a 19 per cent minimum tax on all foreign earnings of US multinationals, and a 14 per cent tax holiday , where all offshore earnings can be repatriated to the US with a one-time tax of 14 per cent. Another investment-related proposal this year relates to carried interest . “I think the carried interest days are numbered,” Riggs said, adding that “that will have far reaching effects on the compensation structure in the alternative investment industry.”

Another 2015 proposal is to tax unrealized appreciation in gifts and bequests – a big issue for clients thinking about whether they should gift their assets or wait until they pass through their estate: one saves income tax, one saves estate tax. “They want to get rid of it all – mark to market at the point of the gift or the bequest and pay income tax at that point,” Riggs said. On a more miscellaneous, non-investment related point, the Green Book anticipates holding shareholders liable for unpaid corporate taxes, which Riggs said “is breaking new ground.”

SMAs versus pooled investments

Returning to the issue of asset and portfolio management, Lee asked Rottschafer of Envestnet to outline the differences between separately-managed accounts and other types of investment vehicles.

“Certainly when investing for taxable clients there is a lot more flexibility within the separate account structure versus a pooled investment like an ETF or a mutual fund – especially from a tax loss harvesting standpoint,” she said. “If you're using separate accounts and have individual securities, not only can you provide some customization with regard to impact investing – if you have social concerns your client would like you to address, for example – but it gives you more flexibility from a tax management standpoint as well.”

Picking up on the tax loss harvesting point, Lee noted that a lot of investors get anxious with the concept of “loss.” Shemesh, who works with Lee at Columbia, manages a systematic tax loss harvesting strategy where, he explained, you can customize an equity portfolio based on a taxable investor's specific needs, and then pursue loss harvesting throughout the year. Lee asked Shemesh which factors influence a fund manager's ability to use tax loss harvesting, and how efficient he thinks current methods are.

“One thing to keep in mind,” Shemesh said, “is...if there is a loss, we're not just selling it and raising cash – we're replacing it with a similar asset.” This activity can also be applied to a basket of securities, he added. On the flip side such a strategy will hang on to the winners that have significant unrealized gains. He then referenced an idea Silverthorne had mentioned earlier about incorporating active financial planning within investing, saying: “Here a systematic tax loss harvesting strategy can be adjusted to accommodate client goals such as charitable giving or annual gift exemption by identifying highly appreciated tax lots within the portfolio for gifting.” Furthermore, such activity can be done throughout the year instead of waiting until year-end.

In trying to determine what a successful tax loss harvesting strategy looks like, Shemesh explained that “you really want to be able to go in and do trades throughout the course of the year, and be reactive to what's available in the market.”

He added: “One thing we know about losses is that they're not predictable. You can't really schedule a date when to loss harvest – they're not conveniently all available at the end of the year.” Loss harvesting can also be “fleeting,” he added, in a sense that there might be a dip in the market, followed by a fast rebound. “You want to be able to essentially capitalize on and capture those losses when they're available,” Shemesh said. “But in order to do so, you need to have the appropriate data-driven infrastructure in place.” Adding to that some technical points as to what factors might influence loss harvesting, there tend to be three, he said: 1) direction of the market 2) volatility of the market and 3) the age of portfolio .

Moving back to the difference between SMAs and mutual funds, Lee then said to Riggs: “We hear a lot about SMAs versus pooled investments – do you have a preference in terms of what you recommend, especially from a tax point of view?”

“I think a lot of it has to do with how tax aware and how tax-driven your client is,” Riggs said. A lawyer by background, he added that a fundamental difference from a legal standpoint between a pooled investment and an SMA account, is that, in a pooled investment, assets are owned and custodied in the name of the pool – investors don't own the asset.

“You have an investment in the pool, and the pool owns the assets directly,” he said. “In an SMA or a UMA, or those types of accounts, assets are custodied in the investor's name – the investor actually owns the asset outright. That may sound like an arcane distinction but it has a tax impact,” Riggs said.

This legal distinction gives rise to a distinct advantage to SMAs, he explained. “Strictly from a tax standpoint, an SMA is generally a more efficient vehicle, and there are two reasons for this. First, you can micro manage the tax effect of individual investments and it also facilitates other tax planning strategies.” The other advantage relates to what he described as an “embedded unrealized gain problem.” When an investor buys into a mutual fund, they're buying at the value of the fund at the end of the day, based on the closing price fair market value and which has an embedded appreciation in it.

“In other words, you may be buying into a tax liability in a mutual fund without realizing,” he said. “There is nothing the fund can do about that. In a hedge fund context, they attempt to mitigate this by using what we call the 'aggregate method,' which attempts to allocate gains and losses to investors based on their tenure in the hedge fund. You can't do that in a mutual fund, so in that sense hedge funds are a more tax-efficient structure than a mutual fund.” Riggs felt that mutual funds made more sense if held within a tax exempt account such as an IRA or 401.

On one final note, Lee noted that there seems to be an uptick in research marketing regarding after-tax investing approaches, and asked Rottschafer “how do you reconcile various strategies and the purported benefits?”

“There are different approaches you can take depending on your client's situation,” Rottschafter said. “If you're dealing with an older individual who has already made all their wealth, and they're sitting on a significant nest egg, they're going to be subject to estate tax, and there is not a lot you can do to mitigate that short of financial planning and life insurance policies, and things of that nature. If you have an individual with concentrated stock...they will have different tax needs. What I think we're seeing with these digital advisory solutions is that they assume away the complexities your clients have.”