The ongoing review and structuring of your portfolio is imperative to meeting your goals as life and/or regulation changes.
In this month’s edition of the roadmap, Joshua Moss sits down with Olivia Jackson, Portfolio Manager on the US Team at London & Capital to discuss key considerations when managing a US/UK compliant portfolio.
Once we have ascertained a client’s attitude to risk and subsequent initial asset allocation, how does this change through time?
Based on an investors ability and willingness to take risk combined with their required and desired return goals, the optimal asset allocation is defined. This is called a strategic allocation and it directs how much weight in % should be allocated to different asset classes.
On top of this, a tactical asset allocation overlay is implemented which aims to take advantage of opportunities. Typically, these decisions involve over or underweighting assets from their strategic allocation weight as the macro-outlook changes or adding small thematic positions that offer long-term opportunities.
Once the portfolio has been built and fully invested, how do you effectively manage contributions/cash balances?
As new cash comes in or builds up in the portfolio (either by being intentionally created or passively generated from assets), the tactical view on the market and business cycle as well as the investors’ appetite for risk will dictate how and when that cash is invested. Particularly during times of market stress, high tactical cash positions can be deployed opportunistically into unfairly beaten down investments to participate in the recovery from the bottom and boost returns.
Does tax impact the way you allocate assets, and do you allocate assets differently based on the wrapper, for example an IRA vs a Brokerage account?
Although tax does not dictate the asset allocation of the portfolio, smart tax-based decisions can be made in the portfolio construction and ongoing management stages that maximise the after-tax return for investors.
From both a capital gains tax and income tax perspective, utilising tax-free and tax-deferred account structures is a key point in the set-up stage. Assets can then be organised into the different accounts to minimise the tax generated. As an example, income tax is typically higher for an investor than capital gains tax so assets that are more income yielding should be organised into the more tax efficient accounts such as IRA’s, whereas lower income and more capital appreciation type securities could be placed in taxable accounts such as brokerage accounts. Although the pre-tax return would be the same, the after-tax return would increase.
With clients being subject to the US IRS and UK HMRC rules, how do you manage this effectively from a tax perspective?
Tax implications are central to the ongoing management of the portfolio. When assets are sold and a capital gain, which is subject to tax, is generated it is important to understand what the tax consequences are. Naturally, higher tax implications of short-term gains in the US means that realized short term gains are avoided altogether if possible. For other gains, an exercise called tax loss harvesting is implemented, if necessary, which sells assets with losses (which can subsequently be bought back if the investment rationale is still strong) that can offset already realized gains to reduce the total capital gains tax bill before the end of a tax year.
This ongoing tax management process also accounts for multiple tax jurisdictions (eg. US/UK) by ensuring the gain or loss on the currency is also incorporated in the calculations. For example, it is possible and not unusual for an asset to have a loss in its local currency A but a gain when measured in a different currency B and, therefore, if the investor is a tax resident in country B then capital gains tax will be due on the liquidation of the asset.
With many clients requiring an ongoing income from the portfolio, how do you manage a portfolio to provide this?
It essential to build known income requirements into the investment plan from the outset. Portfolios are designed to weather changing market environments with every holding playing a key role in the overall allocation of the portfolio.
Scenarios where assets need to be unexpectedly sold to meet income requirements at inopportune periods, such as during market stress, should be avoided. In these cases, not only do we open ourselves up to liquidating assets at excessively depleted prices but selling off assets can also affect the balance and correlations of the overall allocation which was constructed to meet other objectives.
If income streams can be estimated, portfolios can be designed to generate the desired income. Matching the income generating investments currency to the required income currency is also important because short term currency movements can be severe. The income is more stable by eliminating this risk.
What about ad-hoc withdrawals?
If income is unknown and unexpected the approach to dealing with these instances is cognisant of the risks stated above when selling down assets. The first step is to consider the cash level in the portfolio and use this first for ad hoc withdrawals. If there is no choice but to sell assets, the current market conditions must be considered as well as the investors goals to decide which assets are best to sell. The main components that come into this decision is to: avoid realizing short term gains which have undesirable tax consequences, avoid selling the more volatile assets at the bottom of the market, ensure other regular income requirements can still be met and minimise any changes to the risk/return profile of the overall post-withdrawal portfolio.
