Considering Tax Efficient Investment Strategies?

Now that you’ve completed your 2017 taxes, are you wondering about ways that you can make your investment portfolio more tax-efficient in 2018? Have you considered investing in money managers that have low turnover and/or fewer taxable events?

There are countless investment strategies available to investors that meet a wide variety of different investment needs, and not every investment is right for every investor. To help you discover and evaluate different money manager strategies the WrapManager Investment Policy Committee has compiled the following list of four tax-efficient money management strategies.

If you have any questions about how these investment management strategies could impact your portfolio, please feel free to schedule some time with an investment consultant using the button below. The wealth manager that you schedule with would be happy to provide further information about the particular manager(s) that you are interested in and help you assess whether or not the particular strategy could positively impact your holistic investment portfolio.

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4 Tax Efficient Investment Strategies for Your Review

Written by Doug Hutchinson, CFA®, WrapManager's Director of Research and Trading, and a member of the Investment Policy Committee. Doug is responsible for developing and refining manager due diligence and review standards, as well as monitoring and evaluating current and prospective money managers. 

When choosing investment strategies to utilize in a taxable account, an investor and their advisor should have a careful review of the tax impact of any proposed investment strategy. A high turnover strategy, for example, generally leads to more short-term realized gains than a low turnover strategy. Therefore, a high turnover strategy may be more appropriate for a tax-deferred account such as an IRA than it is for a taxable account.

As shown in the hypothetical illustration below from Michael Kitces at Nerd’s Eye View,¹ there is a material difference in wealth accumulation between a portfolio with a 10% annual turnover versus a portfolio with a 50% annual turnover. Both portfolios assume an 8% annual growth and a 15% capital gains tax rate applied to all capital gains.

Important to Note

When evaluating any money management strategy, it’s important to remember that not all investment strategies are right for all people. Depending on your age, goals, current lifestyle, and risk tolerance, you could want more or less equity exposure. The Money Managers and investment strategies mentioned here have varying management styles and investment criteria.

There is no guarantee that these strategies will reduce taxes owed or perform in a more tax efficient way than others. Each individual situation is different and this information is being provided for convenience purposes only. The information presented by WrapManager, Inc. is general information only and does not represent tax or legal advice, either expressed or implied. You are encouraged to seek professional tax advice for income tax questions and assistance. WrapManager, Inc. does not advise on any income tax requirements or issues.

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Over 30 years, the higher turnover portfolio returned 0.24% less (after-tax) on an annual basis.

Beyond the turnover ratio of the strategy, an investor should also evaluate the investment process and methodology to determine if the strategy is tax efficient. For example, a strategy that lets winners run and sells losers will tend to be more tax efficient than a strategy that does the opposite.

Also, a well-diversified portfolio could improve tax efficiency. This is because an investment portfolio spread out across many sectors, industries, and market capitalizations allows for more opportunities for tax loss harvesting. Even in a strong bull market there is typically some sector or industry that is lagging the performance of the broad market. This may create opportunities to harvest those losses by selling those securities and booking a realized loss.

Wondering how the new Tax Bill will impact your investments? Read our Special Report here.

In order to take advantage of loss harvesting opportunities, investors may decide to utilize a managed account structure rather than a mutual fund.

In a separately managed account, also known as an SMA, each investor owns the stocks directly and has their own unique cost basis. As a result, the investor and their advisor can choose which lots to sell in order to minimize taxes. In a mutual fund, on the other hand, all investors have the same cost basis of the underlying shares and individual investors are not able to realize losses that they’d like to take on the underlying holdings of the mutual fund. Also, all realized gains are distributed to shareholders of the mutual fund even if the shareholder didn’t actually participate in those gains.

As always, we encourage investors to discuss any strategies that seem appealing with their Wealth Manager before investing. Without further ado, here are four tax-efficient money management strategies that the WrapManager Investment Policy Committee has compiled for you. 

Brookmont Capital’s Dividend Equity

Founded in 2007, Brookmont’s Dividend Equity Strategy is one of their hallmark portfolios and is focused on long-term total return, downside protection, and reduced short-term volatility. This strategy includes mid and large-cap companies with a blend of value, core, and growth stocks.

ClearBridge Investments’ Multi Cap Growth

Founded in 2012,* ClearBridge’s Multi Cap Growth Strategy takes a concentrated, high-conviction approach by emphasizing stocks across market capitalizations. This strategy concentrates its investments in sustainable growers in the health care, energy, information technology and media sectors with the goal of holding companies for many years to allow for compounding of earnings and cash flows.

*The strategy has been managed continuously since 1983 although the parent company/ownership has changed over the years.

Dorsey Wright Money Management’s Systematic Relative Strength (RS) International

Founded in 2006, Dorsey Wright’s Systematic RS International Strategy seeks to provide long-term capital appreciation through exposure to international equities, primarily using American Depository Receipts (ADRs). This strategy holds approximately 30 – 40 equities and is not limited by style, investment capitalization, or even classification of international market so that it can seek out strong trends wherever they may be found.

Polen Capital’s Focus Growth

Founded in 1988, Polen’s Focus Growth Strategy is a US growth fund with a strong emphasis on sustainable earnings growth. This strategy is a concentrated portfolio of approximately 20 high-quality growth companies, is low turnover with long-term holding periods, and focuses on companies that have high returns on capital and double-digit earnings growth.

Brookmont Capital: Dividend Equity Strategy Brookmont_Logo.png

Low Turnover Approach to Dividend Investing

The annual turnover is about 10% with a range of 5-20%. The Brookmont Dividend strategy buys stocks for their long-term potential and holds these positions for a full cycle or longer

Diversified, Diversified, Diversified

The strategy can pursue opportunities across all market capitalizations, equity styles, and countries of domicile.

The strategy is not overly concentrated in one particular sector or individual holding. Sector weightings are capped at 20% of the portfolio and individual holdings are capped at 5%. The strategy can invest in all economic sectors.

The result is a diversified portfolio with the potential to invest in opportunities wherever those opportunities may be found.

PSN Top Guns Manager of the Decade

The Brookmont Capital Management Dividend Equity strategy was named a Top Guns Manager of the Decade by Informa Investment Solutions’ PSN manager database.**

“We know opportunities exist in all areas of the market. Attractive dividend equities can be found in growth stocks, mid and small caps, and around the world. Limiting the portfolio to large-cap value stocks serves no purpose.” - Brookmont Capital 

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ClearBridge Investments: Multi Cap Growth ClearBridge_Investments.png

Focused on Quality. Guided by Fundamentals

A multi cap strategy is able to participate in the growth, technological advances, and innovations across industries and companies of many sizes.

The ClearBridge Multi Cap Growth strategy has the flexibility to invest in large, medium, and small-sized companies with long-term growth potential.

Many single-cap strategies will sell a stock when it reaches a certain size; a multi-cap strategy has more flexibility.

The Strategy: Unconstrained Flexibility and a Long-Term, Patient Approach

  • Focus on long-term growth across business cycles
  • Exposure to high-quality, impactful companies with new or innovative offerings
  • Flexibility to hold promising stocks for long periods of time – no forced selling criteria
  • Typical holding periods will be 15+ years
  • Extremely low turnover - roughly 5% turnover per year

“A true growth portfolio should consist of stocks that can be held not for a quarter or two, but for many years so that earnings and/or cash flow growth can compound over time.” – Richard Freeman, Lead Portfolio Manager, ClearBridge Investments

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Dorsey Wright Money Management: Systematic Relative Strength International Dorsey_Wright.png

Relative Strength: Simple in Concept, Powerful in Application

A Relative Strength strategy is a strategy that compares performance of a stock to the performance of the overall universe and is used to identify market leaders. Those market leaders are the stocks this strategy seeks to own.

Flexibility

The strategy is not constrained by style (value or growth), investment capitalization (small, mid, or large), or classification (developed markets or emerging markets). This flexibility allows the strategy to go wherever opportunities may be found in the International equity markets.

Disciplined Investment Process

International markets can be difficult to analyze due to different governments, currencies, regulations, etc., but Dorsey Wright is able to evaluate the universe from a technical perspective and build a portfolio based on Dorsey Wright’s proprietary methodology. Their disciplined, technical investment process is not distorted by emotions or biases.

Tax Efficient

A relative strength investing approach tends to be very tax efficient because it will usually let the best-performing stocks run while trimming or eliminating poor performing stocks.

“Why Relative Strength? It relates to Newton’s Law of motion, which suggests that objects that are in motion tend to stay in motion until an extended force acts upon them. So, in the financial world this means that stocks that have good fundamentals, in a market that in general is supporting higher prices, tend to continue to do well.” – Dorsey Wright

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Polen Capital Focus Growth Polen_Capital.png

Low Turnover, Best Ideas Portfolio

The strategy will typically hold only about 20 securities. Since the inception of the strategy in 1989 the portfolio has owned a total of only slightly over 100 companies.

Polen believes that after a certain point of diversification, adding an additional holding increases risk and reduces the growth potential of the portfolio as a whole because sub-par businesses are added to the portfolio.

Polen believes that having a concentrated, best ideas portfolio is optimal because the investor only owns the highest quality businesses.

High-Quality Companies

The portfolio is constructed using a bottom-up evaluation which emphasizes earnings growth, balance sheet quality, free cash flow generation and powerful products and services.

Polen believes that owning these types business will not only contribute alpha to the portfolio but also that these companies are inherently less risky because their earnings stability and strong balance sheets typically results in less volatility during times of market stress.

Time-Tested Process

The experienced investment team has applied their investment process for this product for over 25 years.

“Our expertise is not in predicting short-term movements in stock prices. We have a discipline of identifying and constructing a portfolio of only the most competitively advantaged businesses with wide open opportunities, and nothing less. We also have the patience that is required to let those companies do what they do – compound earnings and returns, usually for a very long time.”

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¹The Tax Risk of Too-Tax-Efficient Investment Strategies

**The criteria used to determine this ranking, is as follows. 

Criteria: The PSN universes were created using the information collected through the PSN investment manager questionnaire and use only gross of fee returns. Mutual fund and commingled fund products are not included in the universe. PSN Top Guns investment managers must claim that they are GIPS compliant. Products must have an R-Squared of 0.80 or greater relative to the style benchmark for the ten year period ending DECEMBER 31, 2017. Moreover, products must have;returns greater than the style benchmark (The PSN Large Cap Value universe is comprised of 232 firms and 344 products) for the ten year period ending DECEMBER 31, 2017 and also Standard Deviation less than the style benchmark for the ten year period ending DECEMBER 31, 2017. At this point, the top ten performers for the latest 10 year period ending DECEMBER 31, 2017 become the PSN Top Guns Manager of the Decade.The content of the Investment Manager Top Guns is intended for use by qualified investment professionals. Please consult with an investment professional before making any investment using content or implied content from any Investment Manager Top Guns. The Investment Manager Top Guns is powered by PSN. PSN is an investment manager database and is a division of Informa Investment Solutions.

Under no circumstances does the information contained within represent a recommendation to buy, hold or sell any security and it should not be assumed that the securities transactions or holdings discussed were or will prove to be profitable.


Important Disclosures

Any money management or investment advisory firms listed on this website are not related entities of WrapManager, Inc. are are listed for convenience and informational purposes only. The listing of a money manager on this website does not imply a solicitation or recommendation of the money manager. WrapManager, Inc. is responsible only for the content of this website and it has no control over other websites that may be accessible from this website, the contents therein or the products/services offered by third parties. Hyperlinks to or from this website do not constitute third party endorsement of, sponsorship by or affiliation with WrapManager, Inc.

The opinions expressed are as of March 31, 2018 and may change as subsequent conditions vary. Information provided in this report is for informational and illustrative purposes only. This material is not intended to be relied on as a forecast, research or investment advice, and is not a recommendation, - or solicitation to buy or sell any securities or to adopt any investment strategy. It is in no way a solicitation or an offer to sell securities or investment advisory services except, where applicable, in states where we are registered or where an exemption or exclusion from such registration exists. While WrapManager, Inc. believes the information obtained from the money managers regarding their strategies is reliable, WrapManager, Inc. is not responsible for any damages or losses arising from use of this information and does not assume any liability for erroneous information provided by such companies.

Strategy descriptions listed represent a brief outline of the portfolio’s objective. There is no guarantee that any manager or product will be successful in achieving the objective described. The strategy used by the money manager listed is not suitable for all investors. This material does not represent a personalized recommendation and does not reflect individual investor’s risk and return goals nor does it serve as the receipt of, or a substitute for, personalized advice from WrapManager, Inc. or any other investment professional. Prior to selecting a money manager it is important you discuss the manager with your financial advisor. Your financial advisor can help you determine proper suitability constraints and objectives as determined from your individual needs and circumstances.

These strategies do not represent a complete list of all investment categories or managers available nor do they represent a complete list of managers or styles that WrapManager recommends to clients. They are being presented for informational and comparison purposes only. Performance of other strategies utilized by WrapManager, Inc. may not be comparable to the performance of the strategies presented in this report. Past performance is no guarantee of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that any specific investment will either be suitable or profitable for your investment portfolio.

Information pertaining to WrapManager, Inc. and Money Managers’ operations, services, and fees are set forth in the respective firms’ disclosure statements, copies of which are available upon written request.

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