Ask any wealth advisor that serves high-net-worth (HNW) clients, the No. 1 challenge that comes up for their affluent investors is, none other than, taxes. Oftentimes, these clients are in high tax brackets and may live in high-tax states, not to mention staying current on ever-evolving tax codes and passing on wealth to the next generation.

For these affluent clients, wealth presents not only unique financial planning challenges, but also strategic tax solutions.

A recent Dynamic Resource Call, “Tax Managed Investing Solutions,” addresses the customized approach HNW investors require. Webinar guests were Vijay Rao, chief investment officer and founder of Vanguard Personalized Indexing Management, formerly known as Just Invest; Len Templeton, founder and president of Templeton Financial Services; and Garett Bjorkman, managing director, Portfolio Oversight Group of CIM’s Private Real Estate Debt and Opportunity Zone investment strategies.

Kostya Etus, CFA® head of Dynamic’s Investment Management strategy, facilitated the call, tapping into the insights of the “all-star team” of guests to deliver “as many solutions as possible” to advisors faced with the tax challenges inherent with HNW clients. The following guest excerpts have been taken from the call:

Vijay Rao on the three customization axes of direct indexing (aka: personalized indexing)

• Tax-loss harvesting. “Instead of having a single ETF, which is a single instrument, if the market’s up or the market’s down, you can only sell that one ETF…I’ve got 300 to 500 different stocks. So, if the market’s up, some of those stocks may still be down. Most of the stocks will be up, but the ones that are down, we can tax loss harvest, we can replace, and we can still hopefully track the index within a very tight tracking error and deliver your clients a little bit of a tax benefit while we’re tracking that index.”
• ESG customizations. Perhaps “…the client doesn’t like guns or doesn’t like oil or doesn’t like tobacco or whatever…your client is opposed to, we can filter out the stocks in those businesses for those specific clients and create a very customized ESG offering based on your client’s needs.”
• Factor tilts. “…factors seem to be more popular two or three years ago before the COVID downturn and ran up and now have downturned again. But there’s a lot of folks who like DFA style factors, for example, or their own factor mix. And by owning individual stocks, we can customize those factor tilts effectively to your heart’s desire, as long as we can get an investible portfolio and really deliver the factor exposures that your clients are looking for.”

Rao reinforced the advantages of tax-loss harvesting for high-net-worth and ultra-high-net- worth clients:

“When they’re in the top tax bracket, they’re in a high tax state and they potentially have gains elsewhere outside of the account that we’re managing. Really the benefits of the tax-loss harvesting pay off a lot more than for smaller clients that may not be in the highest tax bracket. We’ve also seen actually a pretty good use case on the ESG front for smaller foundations and nonprofits that they may only have $5 million or $10 million.

“They don’t have enough money to go hire an investment consultant or do a lot of the things that the institutional folks do, but they do have a lot of ESG customizations. …they’re all mission driven organizations. And to the extent that we can customize a portfolio for them and deliver them a benchmark return and apply their values, they seem to really have found a lot of following in the direct indexing space.”

Len Templeton on the importance of being an active manager

Having built Templeton Financial to “help individuals be on a more equal footing with the big companies and institutions,” Templeton described how the firm starts with the client’s unique tax situation to build customized portfolios. He underscored his firm prides itself on being active managers to:

• Improve security selection – “We spend a lot of time on that.”
• Optimize portfolio construction “on the yield curve in a way that makes sense.”
• Take advantage of inefficiencies in the market – “…there are certain inefficiencies you’ll find in the bond markets that you don’t see in the equity markets.”
• Monitor each individual account from a fiduciary perspective – “…we are constantly monitoring ratios between tax free securities and taxable securities.”
• Build state-specific or state preference portfolios for grater tax efficiency – “…if the client’s better off to go out of state, we will do that. We want to make sure we’re maximizing their after-tax returns.”

An important factor for advisors to consider, notes Templeton, is to “figure out what your (client’s) taxable equivalent yields are.”

He explains, “If you take the tax-free yield and divide it by one minus the tax rate, that’ll give you the taxable equivalent yield.

“It doesn’t take much to be in a 50% tax bracket in California, which means that if I can buy a bond, let’s say at a 4% yield, that’s a taxable equivalent yield of 8%. One of the reasons that’s interesting is because municipals tend to be just slightly less quality let’s say than governments, but better quality versus further rating as compared to corporate bonds. And you don’t tend to have event risk like you do in some corporate securities. So, those types of after-tax yields can be very attractive compared to what you can get in the corporate markets, especially for the same credit quality.”

Garett Bjorkman on Opportunity Zones

The various tax advantaged solutions at CIM are in the firm’s real estate and infrastructure strategies, one of which is specific to opportunity zones. Bjorkman, who joined the resource call webinar from Tokyo, provided insights on:

• What are opportunity zones?
• How do they provide tax benefits to investors?
• How has CIM made certain investments within opportunity zones?

“Opportunity zones were created as part of the 2017 tax and jobs act…a bipartisan legislation that was put into effect to incentivize private investment in low-income communities throughout the U.S.

“Governors of each state were given some criteria through which they had to select areas, ultimately designated as ‘opportunity zones’; investments that met certain criteria and located in an opportunity zone would get some very attractive tax benefits.”

So, how do opportunity zones work? Bjorkman explained…

“If you recognize gain on any type of investment and you invest that gain into what is technically defined as an opportunity zone fund within 180 days of realizing the gain, then you can defer the payment of the tax on that gain until the end of 2026, which would make the gain payable in 2027.”

He notes, “An opportunity zone fund could be just a fund that holds one asset, or it could be a fund that holds numerous assets like you’re typically used to in the fund context, but in this context, it can be one or several assets.”

In addition to the deferral until 2027, “the other benefit that you receive through investing in opportunity zones is that underlying investment itself, so long as you hold it for at least 10 years, when you sell that investment, the gain on that investment is tax free.”

An example Bjorkman points to is CIM’s success in identifying certain communities as opportunity zones…“We acquired a very large asset called Hollywood and Highland, which was a retail and entertainment complex and it was also home to what is today, the Dolby Theatre, where the Academy Awards are hosted every year.

“So, we basically bought the entire block and brought retail and really worked every single angle of the area, bringing in multi-family, bringing in hospitality, really thinking about, how do you bring different asset classes so that you can really create this live, work, play environment and create a community that has the amenities that are desirable to people?”

“We’ve really been very successful reactivating downtown Hollywood as really the top entertainment destination for most people who now visit Los Angeles.” Master planning these types of areas, working with other private developers, city and state not only reactivates these areas, “but also creates attractive before tax returns to investors. And now with this opportunity zone legislation, it really has the potential to create significant after-tax benefits as well for certain investments located in these areas.”

For more on opportunity zones and other tax managed investing solutions for HNW clients, watch the webinar on demand.

Disclosures

This commentary is provided for informational and educational purposes only. The information, analysis and opinions expressed herein reflect our judgment and opinions as of the date of writing and are subject to change at any time without notice. This is not intended to be used as a general guide to investing, or as a source of any specific recommendation, and it makes no implied or expressed recommendations concerning the manner in which clients’ accounts should or would be handled, as appropriate strategies depend on the client’s specific objectives.

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