Inaugural Roundtable Provides Analysis from Eaton Vance, BlackRock and Pence Capital Management on Potential Coming Deluge of Federal Spending
I’m thrilled to welcome you all to Wealth Solutions Report’s inaugural Investment Solutions Roundtable. Each month, we’ll bring together two to three experts to deliver their insights on how current events, new product development and wealth management solutions can – and should – inform asset management and portfolio construction best practices.
As Roundtable Chair, I will focus each month on one key question with a potentially profound impact on the broader wealth management and asset management industries, inviting thought leadership from each roundtable participant that can help members of the WSR community generate actionable ideas and strategies.
Our Participants – From Eaton Vance, BlackRock and Pence Capital Management
For our inaugural Investment Solutions Roundtable, we’re privileged to have participants from three asset management firms who are each widely recognized industry leaders:
- John Moninger, CIMA: Managing Director, Intermediary Sales, Eaton Vance Distributors, part of one of the country’s most well-established investment managers
- Martin Small, JD: Senior Managing Director, BlackRock, the global asset manager, with multiple offerings across multiple asset classes
- E. Dryden Pence III: Chief Investment Officer, Pence Capital Management, the leader in unit investment trusts (UITs) that can be seamlessly aligned by wealth management firms and their financial advisors with their end clients
This Month’s Question – Biden’s Build Back Better Plan
And here’s the question for this month’s participants: How will the Build Back Better agenda influence asset management?
First, let’s cover some key background. President Biden’s Build Back Better Plan is a projected $7 trillion COVID-19 relief, future economic, and infrastructure package that will include investments in infrastructure, housing, education, economic fairness and health care.
The plan is divided into three parts: the American Rescue Plan (a COVID 19 relief package) which passed in March 2021; the American Jobs plan which is a proposal to rebuild America’s infrastructure and create jobs; and the American Families plan, a proposal to invest in areas related to childcare and education.
And where do things stand right now? Well, the American Rescue Plan is the only plan that has been signed into law. Proposals that are featured in the American Jobs Plan has been passed in the Senate through the Infrastructure Investment and Jobs Act (also known as the Bipartisan Infrastructure Deal) which awaits approval in the House until the chamber acts on a forthcoming reconciliation bill. As of September 29, the House vote has not yet happened.
As defined by whitehouse.gov, the Build Back Better Agenda is an ambitious plan to create jobs, cut taxes and lower costs for working families. This will be paid for by changing the tax code for the wealthiest Americans and large corporations.
For today’s discussion, we are going to focus on how this broad legislation could potentially influence economic growth, the stock market, interest rates (inflation) and taxes.
So without further ado, let’s hear from our participants!
E. Dryden Pence III: Chief Investment Officer, Pence Capital Management
We like the “build” part of the plan, believing that it is well overdue. Consider that if every structurally deficient bridge in the U.S. were placed end to end, the distance would stretch from Las Vegas to Seattle. What’s even more unsettling is that over 171.5 million crossings happen on these bridges every day.
However, in our view, the other details of the proposal will cause inflation to spike, which will usher in an era of higher rates. Any time that happens, it tends to weigh on demand.
But in this case, the implications could be much more far-reaching since most of today’s consumers and investors have never had to contend with anything but ultra-low rates.
Throughout most of the 1980s, mortgage rates were well above 10%, and one point eclipsed 17%. So, a hike to 5 – 6% would hardly be shocking for baby boomers and even some Gen Xers. Rates like that, though, would likely rattle millennials and members of Generation Z.
Because 45% of American adults are younger than 45 and given that those groups make up a majority of today’s labor force, it is sensible to believe that were the Fed to boost rates, the impact on consumption could be more meaningful than past hikes.
All of this is why we think this will be a period where experience matters.
Seasoned investors have been through environments like this, but how does an algorithm handle what could be a significant paradigm shift ahead?
John Moninger: Managing Director, Intermediary Sales, Eaton Vance Distributors
The one constant we can always rely upon is change; how we respond is what defines us and sets us apart. We believe education is the answer.
At Eaton Vance, we focus on educating ourselves and our clients about the potential effect of legislation so they can prepare for inevitable change.
The Build Back Better Plan’s (BBBP) proposal will have varying effects on the asset management industry, but I will focus on the House Reconciliation Bill component.
There are a number of key areas to consider, including the following:
- The Municipal Bond Market – The proposed bill will reinstate tax-exempt bonds for advance refundings, which were eliminated as part of the 2017 Tax Cut and Jobs Act. The reinstatement of advance refundings could lead to additional tax-exempt supply and potentially improve municipal credit quality as borrowing costs would lower. The bill would also revive Build America Bonds (BABs). This program could lead to more taxable issuance and broaden the buyer base of municipals, which could stabilize the muni market in times of stress.
- Income Tax – With individual tax rates moving back to 39.6% and a new 3% surtax on income over $5 million, investors will likely be re-evaluating strategies that generate income in their taxable accounts. Therefore, demand for municipal bonds will likely increase even further, balanced by the previously mentioned likelihood of an increase in supply.
- Capital Gains – The bill proposes increasing the capital gains tax rate to 25% from 20%. This could result in advisors and asset managers placing an even greater emphasis on after-tax returns and leveraging various methods to deliver tax alpha. Asset managers increasingly will have to consider the after-tax results of their investment decisions for taxable investors. Managers that employ tax harvesting strategies that are managed with a tax focus 365 days of the year will be in greater demand than those that increase their tax focus periodically.
- Corporate Tax Rate – The Build Back Better Plan proposes a return to a progressive corporate income tax rate with a top rate of 26.5%. The biggest area of impact may be on earnings, which could provide headwinds for some companies. Asset managers will likely review their portfolio of companies and revise expectations while proposals go through the evaluation, modification and adoption process.
Going forward, the biggest opportunity for advisors and asset managers is to provide the education necessary to manage the complexity of taxes on various investments.
Martin Small: Senior Managing Director, BlackRock
Taxes are quickly capturing the spotlight…it’s a topic that clients keep asking about.
In the 1950s, Markowitz posited that risk was a critical factor in understanding investing, which was met with some skepticism at the time, but came to undergird the fundamentals of portfolio construction. Decades later, investors began to accept the impact of fees on a portfolio, as index investments and ETFs grew in prominence and importance.
Now, investing for after-tax returns is emerging as the third wave of modern portfolio design, highlighting the unique challenges for financial advisors who manage individual or family wealth. Institutional investors don’t need to consider how taxes will affect spending.
A retired couple in New Jersey faces vastly different considerations than a New Jersey pension fund. For taxable retail investors, pre-tax returns are irrelevant, effectively a form of “fool’s gold.”
Taxes inject complexity into the already not-so-simple retirement equation.
Having a more prominent focus on tax-smart investing will set savvy advisors apart, creating opportunity for asset managers to educate advisors on topics like tax-loss harvesting strategies, asset location and access to municipal bonds and tax-managed SMAs.
Let’s Get Ready for Next Month’s Roundtable
Thanks so much to Dryden Pence, John Moninger and Martin Small for their analysis and insights!
And as we think about next month’s Investment Solutions Roundtable topic, we’d like to hear from you, the members of the WSR community.
If there is a hot button topic that you’d like to suggest, please let us know. Consistent with WSR’s broader editorial approach, we thrive on reader feedback and recommendations.
Equally important, please take a moment to share this month’s roundtable feature with your colleagues and industry contacts, including via LinkedIn.
I’m looking forward to connecting with you all for next month’s Investment Solutions Roundtable.
Allison Pratt is a strategic advisor to C-suite teams and boards of directors for wealth management and asset management firms across the country. She can be reached at ContributingEd@wealthsolutionsreport.com