Wealth Management Flashcards
Private Wealth Manager Skills
Technical Skills:
* Financial planning knowledge
* Capital markets proficiency
* Portfolio construction ability
* Quantitative skills
* Technology skills
* Language (bilingual) skills.
Soft Skills:
* Communication skills
* Social skills
* Education and coaching skills
* Business development and sales skills
Ethical Considerations for Private Wealth Managers
- Fiduciary duty and suitability
- Know your customer (KYC)
- Conflicts of interest
- Confidentiality
Private Client Segmentations
Robo-Advisors:
* The less affluent
* Work in a similar way to normal advisors;
Mass affluent:
* Highest number of clients per manager
* Less-personalized investment service
* Charged brokerage based on AUM.
* Likely have other financial planning needs
High-net-wealth (HNW):
* Fewer clients per manager
* Greater customization of investment services
* Likely have other financial planning needs
Ultra-high-net-wealth (UHNW):
* Few clients per manager
* Highly customized investment services
* Generally multigenerational in nature
* Likely to have complicated estate planning needs
* Likely have other financial planning needs
Some Personal Information Needed from a Client
Information Needed:
* Family situation
* Identification
* Additional career information
* Investment Background More details on financial goals and risk tolerance
* Current employment
* Experience with market volatility
* Interest in meeting specific goals or a particular return objective
* Liquidity needs
* Investment preferences based on his environmental and social concerns
* Background Information
* Investment Objectives
Types of Finanical Statements
Net Worth Statement: (personal balance sheet) It lists and values their assets and liabilities. Net worth
Holistic (Economic) Balance Sheet: is “Economic Net Worth” which includes the present value of non-marketable human capital and non-vested pensions (assets), and the present value of lifetime consumption and bequests (liabilities).
Statement of Cash Flows
Basic Tax Strategies
- Tax avoidance: Is the minimization of tax through mechanisms like tax-exempt accounts or gifting rules
- Tax reduction: This involves minimizing tax by investing in tax-effective investments
- Tax deferral: This involves minimizing tax by deferring tax liabilities
Types of Goals
Planned Goals: Can be reasonably estimated in terms of size and timing, and typically include
* Retirement
* Education
* Specific purchases
* Family events
* Wealth transfer
* Philanthropy
Unplanned Goals: Are more difficult to predict, but that are still very important, include
* Uninsured medical expenses, or care for elderly relatives
* Uninsured property repairs
* Other unforeseen expenses
The Wealth Manager’s Role
Plays a key role at clearly identifying and defining their:
* Quantifying financial goals
* Prioritizing financial goals
* Changing client goals
Types of Risks
Risk Tolerance: A client’s willingness and ability to take on investment risk.
Risk Capacity: A client’s ability to take on investment risk.
Risk Perception: How client assesses investment risk.
Risk Aversion: How the individual behaves when faced with negative outcomes.
Capital Sufficiency Analysis
Steps: Evaluate capital sufficiency in relation to client goals.
* Assess whether a client has the capital required to meet their financial goals (capital sufficiency or needs analysis).
* Deterministic forecasting: Uses the expected return to calculate whether the portfolio will meet their objectives
* Monte Carlo simulation: Allows to simulate many potential future outcomes based on assumed probability distributions.
* Other inputs include correlations, taxes, interest, and fees.
Types of Retirement Needs Analysis
How much capital an individual needs in retirement:
* Mortality tables
* Annuities
* Monte-Carlo simulation
Retiree Behavioral Tendencies
- Heightened loss aversion
- Consumption gap
- Annuity puzzle
- Investment income preference
Components of an IPS
The main components are:
* Background and investment objectives
* Investment parameters
* Portfolio asset allocation
* Portfolio management
* Duties and responsibilities
* IPS appendix
Background and Investment Objectives
Section of the IPS that details the client’s relevant details and their investment needs. This is the “why” and “what” of the IPS.
The client’s background information is likely to include:
* Market values of, accounts, and portfolios
* The client’s tax status
* Expected cash flows
Common financial objectives include:
* Retirement income needs
* Supporting family members
* Funding philanthropic activities
* Meeting bequest goals
Investment Parameters
Key investment preferences and includes:
* Risk tolerance
* Investment time horizon
* Asset class preference
* Other investment preferences
* Liquidity preferences
* Constraints.
Portfolio Asset Allocation and Management
Details the target asset allocation for the client based on their investment objectives and parameters:
* Discretionary authority: Full discretion, Partial discretion, or Non-discretionary
* Rebalancing
* Tactical changes
* Implementation
Duties and Responsibilities
Outlines the responsibilities of those implementing:
* Drafting and maintaining the IPS
* Developing, monitoring, and rebalancing an appropriate asset allocation
* Recommending or selecting investment options
* Monitoring costs and third-party service providers
* Reporting performance and taxes
* Voting proxies
* Assisting with private fund offerings
IPS Appendix
Additional information related to the management of the client’s objectives:
* Modeled portfolio behavior
* Capital market expectations
Portfolio Construction Aprroaches
The 2 main approaches are:
* Traditional approach
* Goals-based approach
Traditional Portfolio Construction Approach
The steps are as follows:
1. Identify asset classes
2. Develop capital market expectations
3. Determine portfolio allocations
4. Asset constraints
5. Implement the portfolio
6. Determine asset location
Goals-Based Portfolio Construction Approach
Step 3 Determine portfolio allocations of the traditional approach is where the goals-based approach is different.
* Involves allocating the client investments to each of the client’s goals (goal buckets).
* Looks to set maximum volatility levels or minimum probabilities of success for each bucket.
* Advantage: Helps the client to determine and monitor different investment objectives with more ease.
* Disadvantage: The resulting combined portfolio might not be mean-variance efficient.
Items in a Portfolio Report
Items to put in a Portfolio Report:
* An asset allocation report that reflects strategic asset allocation targets
* A detailed performance report
* A year-to-date performance summary report and a historical performance report
* A transaction details report showing contributions, withdrawals, interest and dividends, and capital appreciation for the current period
* A purchase and sale report for the current period
* Currency exposure report detailing the effects of exchange rate fluctuations
* A benchmark report that shows the performance of the portfolios asset classes
* An accompanying letter that provides market commentary, investment context, education, and other advice
Investment Plan Evaluation
Evaluating the success of client investment program might be expressed in either:
* Absolute (real return)
* Relative terms (return above a benchmark)
* Relative risk-adjusted return or downside risk.
Ways to Mitigate Double Taxation
Tax authorities can recognize this issue through various means:
* Franking credits: investors only pay any surplus of their income tax rate over the corporate tax rate.
* Qualified dividends: Lowering the tax rate for dividends on shares that are held for a minimum time
Types of Accounts
- Taxable account: Normal tax rules apply
- Tax-deferred account: Contributions are made on a pre-tax basis, returns are tax-free. Withdrawals are taxed at ordinary income tax rates.
- Tax-exempt: No taxes are applied to contributions, returns, or withdrawals.
Tax Systems
Tax havens: are a region/country with very low or zero tax rates for foreign investors.
Territorial tax systems: Tax locally generated returns. Returns earned outside of the locality are not taxed.
Worldwide tax systems:
* Tax all income of residents regardless of where in the world it is earned.
* This could give rise to double taxation.
* Tax credits or treaties can mitigate the effect of this double taxation.
* Usually based on the residence of the investor, but USA tax rules, is based on citizenship.
Asset Location
Is the process of assessing which asset classes should be held in which types of account.
The general rule, tax-efficient assets are less impacted by taxation, they should be held in taxable accounts, leaving less tax-efficient assets to benefit from tax-exempt or tax-deferred account status.
Potential Capital Gain Exposure (PCGE)
- A specific issue with mutual funds new investors in the fund buys into any unrealized capital gains tax liabilities of the fund without benefitting from the historic price appreciation.
- In order to investors to assess these unrealized capital gains, mutual fund data providers publish metrics
- A fund with a high PCGE has high potential capital gains tax liability for new investors
- This measure can be negative for funds with embedded net capital losses, which implies the ability to offset these capital losses against future capital gains.
Quantitative Approach to Tax Management
Can be used to carry out the following 3 tasks:
* Transitioning: From their existing portfolio to a new portfolio in a tax-aware and risk-controlled way.
* Tax-optimized loss harvesting: Systematically analyzing opportunities for tax loss harvesting that present themselves during the year.
* Gain-loss matching optimization: Assessing the optimal strategy with respect to realizing gains in order to avoid risk imbalances in the portfolio verses the portfolio objectives.
General Risk and Tax Considerations Relating to Concentrated Positions
- The level of company-specific risk inherent in the concentrated position. This is likely to be greater for private companies than for larger, more established public companies.
- The reduction in portfolio efficiency due to the lack of diversification.
- The liquidity risk inherent in the position. This is likely to be higher for privately held positions
- Any capital gains tax liability realized should the asset be sold. It is highly likely the concentrated position has seen long-term price appreciation and has a very low tax basis.
Appropriate Strategies for Dealing with Concentrated Positions
6 Approaches:
1. Outright sale
2. Staged diversification
3. Hedging and monetization
4. Tax-free exchanges
5. Charitable giving
6. Tax-avoidance and deferral strategies
Strategies to Equity Monetization
- Sell the security short while maintaining the original concentrated position.
- Sell a forward contract on the concentrated position.
- Enter a total return swap, paying the return on the concentrated stock; receive a fixed or floating rate
- Construct a zero-cost collar
Exchange Fund
Tax-Free Exchanges using a Partnership:
* Allows investors to contribute their low-basis stock position in exchange for a share in the fund.
* The exchange itself is not a taxable event
* When the investor redeems from the fund, they receive securities equal in value to their share
* The investor cedes control of the investment to the manager of the exchange fund who has discretion
* The fund also must hold at least 20% of the portfolio in “qualified assets” such as REITs
* Fees for redemption and management
Charitable Remainder Trust (CRAT)
- Irrevocable donation of to a trust and receive a tax deduction for the gift.
- Within the trust, the securities could be sold and reinvested in a diversified portfolio.
- The trust would provide income for the life of its named beneficiaries
- When the last-named beneficiary dies, any assets remaining in the trust would be distributed to the charity named in the trust.
- Could be used as a strategy to reduce concentrated positions.
Strategies for Raising Liquidity from a Concentrated Positions in Privately Owned Business:
- Initial public offerings
- Sale to a third-party investor, or an insider
- Divesture of non-core assets
- Personal line of credit
- Leveraged recapitalization
- Employee stock ownership plan (ESOP)
Strategies for Managing Concentrated Positions in Real Estate
- Outright sale
- Mortgage financing
- Donor-Advised fund (DAF)
