Storytelling: Q&A with CEO Jack Markwalter
Tax Reform: Goodbye Estate Tax?
A New Outlook for Small-Cap Stocks
THE ADVISOR Insights for Integrated Wealth Planning
ECONOMIC & INVESTMENT OUTLOOK
A turning point and a time of significant change bringing complicationsâ€” and opportunities.
Q1 2017 CONTENTS
Telling Our Family Story: Q&A with Atlantic Trust CEO Jack Markwalter........Page 2
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2017 Economic & Investment Outlook: Inflection Point ................................... Page 4
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Atlantic Trust in the News Reuters: Strong Auto Purchases Lift U.S. Retail Sales; Inflation Stirring Estate Planning Post-Election: Goodbye Estate Tax? ........................... Page 8
CNBC: Why Naming Rights for Wealthy Donors Can Be More Than Just Bragging Rights
ALSO IN THIS ISSUE:
Bloomberg: Brexit Scars Made Wall Street Masters Timid Election Bettors
The Wall Street Journal: Be Careful When Passing Down a Roth IRA
Once Upon a Time............................... Page 1 Tax Reform: What, When and How ........................ Page 10
Socialize With Us
Bigger Things Might Come in Smaller Packages .......................... Page 11
Kyle W. Marotta: 6 Habits of People Who Achieve Early Retirement
Takeaway: Delaware’s Trust Laws on Decanting Existing Trusts................. Page 13
Read featured blogs at blog.atlantictrust.com:
Rebecca W. Milliman: Women’s CIRCLE Meets to Discuss Legacy Legends in Chicago David L. Donabedian, CFA: Atlantic Trust Post-Election Update Webinar Paul M. McPheeters, CFA: OPEC Meeting in Vienna—Incremental Positive
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nce upon a time...
any people can recall older relatives telling the proverbial “When I was your age” stories—about how they had to walk long distances to school in all types of weather or walk to town to get groceries. But what if generations ago one of your relatives actually walked 1,000 miles looking for a new life and a new opportunity and started a small business, one that later grew into a business empire in which multiple generations have been involved and that has been the source of tens of millions of dollars in contributions to education, the arts and the environment? That’s not just a story about creating wealth (and it is a true story), the story itself is real wealth. Every family has a narrative. It may be along the lines of “We came to this country with nothing and we made a fortune” or along the lines of “We had it, and then we lost it” or, as for many families, “We’ve had ups and downs and big successes and big failures, but we always remained a family.” From our work with thousands of multigenerational families over the decades, we know that sustaining family wealth and legacy across generations is a high priority. We also know it is not easy—it requires creating an environment that fosters and supports it. One of the best practices to sustain legacy is to tell the family’s stories. “This is a very dynamic process,” says Catherine L. Schnaubelt, managing director and senior wealth strategist for Atlantic Trust in Houston. “Sharing the family’s history,
culture, values and path to wealth creation is a way for all generations of a family to really connect. The family story frames the focus and intent of legacy planning.” James Hughes, a well-known family consultant and author, says that failure to tell the family’s stories is one of the contributing factors in the failure to preserve wealth over multiple generations. “These stories are the glue that binds together the individual members of the family. Family stories give members a sense of the unique history and values they share, their ‘differentness.’ A family that does not inoculate its young against childhood diseases would be risking its most precious assets. Failure to inoculate the family’s young against entropy with the vaccine of its history and the values that are contained in its stories is similarly risky.”* Schnaubelt says that the place to start for a family interested in committing to documenting their story is simply: What do we want out of this? “Some want to preserve the history of a family business,” she says. “Others want to express how they embraced stewardship of their wealth by documenting their philanthropy and answering the ‘why’ behind the family’s giving. Most want that feeling of connection across the generations and the sense of belonging to something greater than yourself. The very process of a family coming together to share stories is a rich exercise that provides both context and texture to a family.”
Often, a very common reaction among family members is as simple as “Wow, I didn’t know that.” Such was the case with Atlantic Trust CEO John “Jack” S. Markwalter Jr., whose parents recently wrote the family’s story. “There were stories I had never heard and questions I never expected,” says Markwalter. “The answers to those questions provided new connections within the family and across generations.” The start of a new year is often a time for reflection and for setting new goals. As the writer Rainer Maria Rilke put it: “And now we welcome the new year—full of things that have never been.” Your family’s stories have always been there, but if capturing them is one of those things that has “never been,” we hope the Q&A with Markwalter, on the next pages, will inspire you to make this a goal for the new year. While you may not discover the relative many generations removed who once upon a time walked 1,000 miles for a new life, you’re likely to discover the uniqueness of your family. More important, says Schnaubelt, “You’re likely to discover, and really appreciate, the different types of glue that hold your family together and the answer to the question ‘What does our wealth really mean?’” Please ask your advisor about our Storytelling Workshop, Family Crest and our other G2G Impact: 3 Principles workshops and retreats available to help you and your family with legacy planning. *”Family Wealth: Keeping It in the Family,” James E. Hughes Jr., Bloomberg Press, 2004.
elling Our Family Story
Q&A with Jack Markwalter Atlantic Trust’s CEO For a family pulling its collective story together from many people, the process is like the first line of Edith Wharton’s novel Ethan Frome: “I had the story, bit by bit, from various people, and, as generally happens in such cases, each time it was a different story.” When Atlantic Trust CEO John “Jack” S. Markwalter Jr. led the effort to create a book with his parents telling their story and those of their ancestors, he realized that he knew only bits and pieces of it. When the project was complete, he received not just the fuller-picture story, but much more of its meaning and significance. Now, it is a gift for generations of their family to cherish and enjoy.
Tell us why your parents decided to record their family story and what the process was like. I had been thinking about this for a while, planning to recommend it to my parents. Then Atlantic Trust hosted “Your Family’s Legacy,” a speaker series event on capturing your family story, and what a speaker said about losing his parents and wishing he’d captured their stories really had an impact on me. Because my father is renowned as a great teller of stories, I was inspired to move forward. Ironically, one of the beautiful things that came from this was that my mother’s voice really came alive as well—we just had not heard many stories about her family. We followed an outline of questions from the person we engaged to help us and also included questions from members of the extended family—in addition to my parents, my three siblings and I were involved, as were 16 grandchildren, and probably 30 family members in all. The younger generation, in particular, asked questions we never expected and
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we got answers and heard stories that surprised us. One of my nieces wanted to know, “Why does Granddaddy put ice in his milk?” I’ve seen him do that for years and I never knew why or thought to ask. Several of the younger generation asked, “What was it like when Granddaddy and Grandma were dating?” It was hard for them to even grasp that their grandparents were once teenagers! I think everybody in the family would agree that it was extremely engaging and a very creative and insightful project that we all loved.
Did your family discuss the process and the “results” afterward and, if so, what did that reveal? In addition to capturing the stories on paper, my parents did several days of interviews on video and we created three versions, each a different length, including a full-length version for our family archives. We gathered as a family two Christmases in a row, watching the “highlights” version the first year and
the movie-length version the second year, and then talked about them. Actually, we mostly laughed, marveled at what we had discovered and, most especially, were just incredibly grateful for what we had as a family. Although all of the grandchildren have seen the book, we made a collective decision to give a wrapped copy of it to each grandchild as he or she turns 21. It makes the book that much more special, and they can truly appreciate it at that age. At one point early on, we debated having just a very detailed family ancestry tree, but felt we would miss the magic of our family’s history. The stories allow you to “live” through a certain period with your ancestors.
You discovered that your ancestors were stonecutters in Germany. Tell us about that. My parents had a large framed print of the grand cathedral in Cologne, Germany, on the wall in their house—frankly, I had no idea why we had that picture. One of the stories I’d never heard was that my father’s
Jack Markwalter Sr. and cousins on a lengthy fishing trip with Uncle Johnny. “Any time you went in the car with Uncle Johnny, it was an adventure. He never had a schedule, and he told my mother, ‘Look for us when you see us!’ Mother was sometimes frustrated when we went off with Uncle Johnny and she didn’t know when we were coming back.”
grandfather, who was born in Germany, and all of his brothers were stonecutters. My great-grandfather eventually moved here to the U.S., and when my father was young, he would go to his home and my great-grandfather would show my father how to use the hammer and chisel he kept in the backyard. Then we learned that multiple generations of the family had been stonecutters and had worked on the cathedral in Cologne, going back some 700 years ago. My father found a certificate for completion of an apprenticeship to become a journeyman stonemason for
one of his ancestors. We also learned that Markwalter men carved a number of memorials in the South after the Civil War, including a well-known one that my greatgrandfather and his brothers carved in the 1870s in downtown Augusta, Georgia, where I grew up. It was an incredible discovery that means a lot to me— knowing that multiple generations created things of such permanence, working with their hands. And that photograph of the cathedral finally makes sense!
There’s a strong business theme among more recent generations of the family. What is most meaningful to you about the dairy farm story, in particular? The founder of a major retail chain used part of his fortune to acquire a small dairy in Florida. To expand, the company bought an Augusta-based dairy and hired my grandfather, an accountant, to help with the transaction. When the time came to close the deal, the dairy didn’t have any money to pay my grandfather, so they gave him stock instead—pretty worthless at the time, but over the years it grew into one of the largest dairies in the world. Eventually, the dairy merged with another company and got out of the dairy business.
My grandfather held on to his stock, and it provided well for the family over the years. When my father and his siblings turned 21, they all got stock. Because my grandfather also invested early on in a small bank in South Carolina that later became a major national bank, one of my aunts got this stock. That bank stock put her eight children through college—no small thing to a mother of that many children! I think of this when we talk to our Atlantic Trust clients about wealth management and legacy planning—specifically, this question: “What is the money for?” The point isn’t the investment itself, it’s how that can enable families to achieve their goals and dreams for their children and grandchildren and how we can give back to make the world a better place.
What’s your best advice for clients who may be thinking about telling the family’s story? It’s a wonderful way to connect generations. The commitment and the effort you’ll put into the project will be well worth it, as the record of your family’s living history will be the most valuable “portfolio” you could ever have.
Faith. Family. Friends: How a Family’s Values Come to Life MARKWALTER
M FAITH. FAMILY. FRIENDS
Many people may think a family crest is only for royalty or for English, Scottish or Irish clans whose crests go back thousands of years. Not so—in fact, there’s no reason any family can’t have its own crest. Jack Markwalter’s family recently developed its crest, working through the elements of a crest and their purpose: The motto is what the family wants to stand for in the world; the supporters are the core principles that support the family; the shield elements are the four core values that guide family decision-making. “Our motto and three priorities are faith, family and friends,” says Markwalter. “The visual elements are faith, work ethic, knowledge/education and sports—pretty big in my family, with five sons. The retriever dogs represent loyalty and affection. We included a shamrock because we have Irish relatives on both sides of the family. These are the things that bind us together.” Through our G2G Impact: 3 Principles offering, Atlantic Trust can help your family develop its own crest in our Family Crest Workshop. Please ask your advisor for more information.
ECONOMIC & INVESTMENT OUTLOOK
After several years of “normalization,” our theme for 2017 is “inflection point.” Forget what you may have learned in calculus—that an inflection point is the point where the direction of a curve changes. Instead, think of inflection point’s other definition: a time of significant change in a situation; a turning point after which a dramatic change is expected to result. “Go for growth.” Once the 2016 presidential election result was known— without a market meltdown during the following days—the message from the president-elect became that growing the economy, and quickly, is the highest priority. That much is clear from Presidentelect Donald Trump’s 2017 economic agenda, put forth less than 24 hours after his win: significant corporate tax reform and personal income tax cuts, major infrastructure spending, a defense buildup and a deregulation push. “But before we focus on that agenda and its implications for the economy and the markets, it’s important to emphasize the cautionary tale in the lack of the ‘expected’ downward market reaction after the election,” says David L. Donabedian, CFA, chief investment officer for Atlantic Trust. “It’s imprudent to make radical portfolio decisions based on a single event outcome. Brexit, with its initial-shock negative reaction followed by a market recovery, was a recent lesson about not overreacting. And so was the U.S. election.”
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It’s clear that growth will be welcome— and not just as a philosophical economic goal. President-elect Trump won in large part because many people feel that the economy has been providing them less opportunity than in the past. Beginning in the mid-1980s, real GDP growth has looked a lot like a down escalator, says Donabedian. [See chart.] “Economic expansion in the mid-1980s averaged 4.9% a year, followed by 4.3% in the 1990s. Then it downshifted to 3% a year and, in the current recovery, it’s been barely 2% a year. The economy is now $2.6 trillion smaller than if it were growing at a 3% rate. Wages have been stagnant and families’ standards of living have stalled. A fiscal stimulus plan is theoretically a highrisk, high-reward approach, but it may help alleviate some of the economic pain many people are feeling.” In fact, wages are beginning to pick up some—average hourly earnings were up 2.4% in 2016 through the end of October.1 However, previous periods of full employment saw wage growth in the
range of 3.5% to 4%. “Unemployment was at 4.6% as of the end of November, and 5% is considered ‘full employment,’” says Gary E. Pzegeo, CFA, head of fixed income for Atlantic Trust. “A certain faction within the Federal Reserve believes that the current headline unemployment rate is not giving a good enough signal to adjust interest rate policy, precisely due to this lack of empirical evidence. Nonetheless, the Fed raised rates by a quarter point in December, and we expect they will raise them again in 2017. Of course, even a good rate of wage growth is a moot point if you’re out of a job. Those are the people hoping that the next phase of the economy does offer them more opportunity. Typically, economic expansions last about six to six and a half years—and we’re past that now. But we haven’t experienced built-up excesses like we’ve had in other recoveries. It’s still a Goldilocks economy and there’s no reason to think that even though this economy is ‘due’ for a downturn because of its age that we’ll see it turn lower any time soon.”
Politics Never Ends While Paul Ryan’s position as speaker of the House is now secure and the Congress is indeed GOP-controlled—both key to enacting the president-elect’s policy agenda—political maneuvering continues while investors consider the implications of policy outcomes. “The most significant
Two important Cabinet nominees— Steven Mnuchin as secretary of the Treasury and Wilbur Ross as secretary of Commerce—are both fairly conventional choices, says Donabedian, in that they’re market-oriented, experienced as private investors and well-schooled in how finance and capital markets work. “These two Cabinet secretaries are critical to moving the economic agenda forward,” says Donabedian. “Mnuchin would be the point person on selling tax reform, which is estimated to cost as much as $6 trillion over the next decade without offsets. The Republican-controlled Congress is unlikely to support that, and the bond market almost certainly will not.” In early December, Mnuchin maintained that tax cuts would generate more jobs, which would help offset the cost of lost revenue. The independent Tax Foundation, however, estimates that even with what is called “dynamic scoring” (a tool for Congress to evaluate the trade-offs in tax policy changes), Trump’s tax package could cost about $3 trillion over a decade.2 [Please see our article on page 8 about the likelihood and timing of tax reform.] Ross would be the point person for trade—and for bridging the significant ideological divide between Trump and many Republican lawmakers, who generally support free and open trade. (Trump attacked the North American Free Trade Agreement as far back as 1993.) A trade war could be very detrimental to U.S. businesses and consumers alike.
More than 11.5 million U.S. jobs depend on trade, according to the Commerce Department. Boeing, for example, gets 70% of its revenues from sales abroad; China is its largest foreign customer.3 “A reduction of global trade and competition is a recipe for slower growth and higher inflation—a bitter mix for both stocks and bonds,” says Donabedian. “Substantial global linkages have been built over the past 30 years and will not be unbound smoothly. In addition, about 40% of corporate profits of S&P 500 companies come from abroad and foreign entities own more than 40% of U.S. Treasury debt. A trade war has no winners. New tariffs would be a significant drag on global growth. Trade may be the biggest risk for the markets in 2017.” Both Mnuchin and Ross “professed confidence” in the new administration’s ability to boost economic growth to as high as 4% a year—but without specifying a time frame.4 “Fiscal stimulus could boost the economy’s growth rate to 4%, but not sustainably,” says Pzegeo. “The economy was showing signs of strengthening even before Trump won and laid out this aggressive growth plan. Third-quarter GDP came in at 3.2%, the strongest
growth in two years. So, we were already seeing a bit of acceleration. You can give a jolt to the economy and put more money in people’s wallets and in business coffers and definitely get a period of 4% real GDP growth. But to get sustainable 4% growth, which would be double what we’ve had for the past five years, would require substantial productivity improvements. If you substantially improve the quality of roads, bridges, airports and so on, it will improve the productivity of the economy, but those projects can take years—in the case of an airport, up to 10 years.”
Key Market Sectors: Major Changes Ahead Since March 2009, the S&P 500 has been up 220% and been remarkably stable. But this seven-year bull market, the second longest ever, is often considered as tired and the most unloved bull market ever. “It’s true that, overall, the market had gotten to be a bit boring prior to the election, which was reflective of a lowgrowth, low-return environment devoid of upside or downside catalysts,” says Bryan G. Reilly, senior vice president and senior investment analyst in Atlantic Trust’s Boston office. “Many people have
The Shrinking Economic Expansion Real GDP Grouped by Average Growth Rate, Last 6 Expansions 10.0
U.S. Real GDP Growth, YoY, %
of these policy issues are whether we’ll see a more ‘activist’ fiscal policy, whether free global trade is at risk, how the regulatory environment may change and how this will affect several key market sectors,” says Donabedian. “Even in the days remaining in January, clarity on these issues will determine whether market volatility remains fairly subdued or whether it spikes in reaction to perceived higher political and policy risks.”
4.0 2.0 0.0 -2.0 -4.0 -6.0 1967
Source: Cornerstone Macro. Data as of 09.30.2016. Shaded areas indicate recession.
Investments Five Initiatives That Could Add $3.5T to GDP by 2025 The blue bars below represent the low and high ends of a McKinsey & Company estimate of how much each of these initiatives could add to the U.S. GDP by 2025. Accelerate digitization of lagging sectors and firms Broaden participation in global trade and investment Develop rapid training pathways for the workforce Invest in urban housing and transportation Facility innovation and productivity growth in energy sector
Source: IMF, DECD USCBO, Conference Board and McKinsey Global Institute.
the perception that the market’s rise of more than 200% off its 2009 bottom and the economy’s growth of only about 2% per year just don’t ‘fit’—we’ve seen a reluctance to really accept the rise in stocks. In fact, money has flowed into bond funds for the past six or seven years and out of stock funds, which is counterintuitive to how the market has been performing.” Certainly, there’s a heightened interest in the markets going into 2017 because of the transitions ahead and, specifically, in the key equity sectors of energy, healthcare, defense and financials. In general, we can probably expect less political interference in pipeline construction, the halt on the Dakota Access Pipeline notwithstanding, and a green light for many of the 20+ pipelines that have been stalled or rejected since November 2015. “It’s a pretty unanimous feeling that President-elect Trump’s win is an unambiguous green light for the fossil fuel industry,” says Reilly. The win by Donald Trump had generally been viewed as very positive for the pharmaceutical segment of healthcare, but drug pricing actually may be under threat. Trump has said he favors importing less expensive drugs; the GOP-controlled Congress is less enthusiastic. Certain segments of healthcare potentially may
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face more headwinds. “Depending on what the replacement for Obamacare is, Medicaid HMOs could be hurt, along with hospitals, which may see a return to uninsured patients in their emergency rooms and inpatient rooms,” says Reilly. “On the other hand, we may see fewer taxes on medical devices and insurance companies. Overall, the healthcare industry will be under increased scrutiny.” The defense budget was already beginning to turn more positive, after years of sequestration and negative growth. The new administration is likely to increase defense spending, welcome news to aerospace and defense contractors, whose revenue has declined every year since 2013.5 Retail stocks look to see a continuation of their difficult 2016 into 2017. Reasons vary—from the strength of e-commerce to a strong U.S. dollar to a growing disinterest in “consumerism.” “For millennials, in particular, experiences and travel may be more attractive than buying new clothes every season,” says Reilly. The financial sector could benefit under the new president’s administration. While the complex Dodd-Frank Act isn’t likely to be repealed because that would require 60 votes in the Senate, provisions within it may be significantly watered down, such as those regulating regional banks and insurers.
One thing seems clear: We should expect to see continued sharp gains in small- and midcap stocks. Since the election, the Russell 2000 Index has jumped by roughly 15%. Smaller companies will be helped most by cuts in the corporate tax rate (proposed to go from 35% to 15%) and by loosened regulations on banks that offer credit to small firms. They should also experience less of a headwind from a stronger U.S. dollar. [See article on page 11.] The outlook for U.S. small- and mid-cap stocks is one reason the Atlantic Trust Asset Allocation Committee recommended in December a shift in favor of small and mid-caps versus developed international markets. As for bonds, because there’s been an expectation of higher interest rates, “our defensive stance has been warranted,” says Pzegeo. “We’re looking at what could happen down the road regarding tax reform and a spending plan, and we’re positioning portfolios to take advantage of the potential yield curve change. Because there are three distinct factions within the GOP in Congress, including a sizable group of very staunch fiscal conservatives, a tax cut plan that significantly adds to the deficit is not a done deal. The outcome of this is a critical piece for us in analyzing where the bond market will go.”
A Hedge Fund Reversal? A prolonged period of poor performance, but an exciting time—The first part describes the last several years for hedge funds, while the latter describes the environment for a group of focused hedge fund opportunities in which Atlantic Trust invests. “The hedge fund sector overall had rough years in 2014 and 2015, and through the early part of 2016,” says Ohm M. Srinivasan, CFA, managing director and co-manager of hedge funds for Atlantic Trust. “But since the spring of 2016, we’ve
QUICK SMARTS Wealth Strategies From Our Atlantic Trust Team seen a positive reversal in some of the opportunistic strategies we like. One reason is that the opportunity set is expanding; the other is that the amount of capital chasing these opportunities has shrunk. That’s a good combination. In fact, we believe the current opportunity set is the best we’ve seen in seven years.” The top thematic winners in 2016 were stressed performing bonds and healthcare innovation. A closer look at one of these themes—healthcare innovations—reveals why its performance as a theme was up +25% the last half of 2016: It’s essentially the story behind new cures and treatments for rare diseases, orphan diseases and cancer. “New Food and Drug Administration (FDA) approvals of molecular entities and biologics are up from 20 in 2005 to 43 in 2015 as technology has speeded up the research timeline for genome-based therapeutics,” says Srinivasan. The big takeaway on hedge funds, according to Srinivasan, is that it’s imperative to ignore the term “hedge funds”—now a 10,000+ strong universe—and focus on the quality of the manager in highly specific and carefully selected opportunities. Strategy and manager selection have become more critical than ever. The likelihood of certain policies in the new administration is another factor in the positive outlook for hedge funds. “Divergence” among central bank policies around the globe is the key word. “When policy around the world converged, such as in the past four or five years, it’s harder for managers to find good opportunities because everyone is moving in the same boat with the same tide, so to speak,” says Srinivasan. “As of now, Trump is signaling that his policies will increase the divergence of U.S. policy versus the rest of the world, which adds to the opportunity set.” Looking ahead, the major theme for 2017, says Donabedian, is “inflection point.” “We’re going from a monetary policy-driven environment to a fiscal policy-driven one,” he says, “from extremely low interest rates and low inflation to higher interest rates and somewhat higher inflation, and for at least a period of time we’re likely to go from very sluggish economic growth to stronger economic growth. Several years of declining deficits will likely pivot to a substantial increase in the deficit. If the dollar continues strengthening, that will act as a restraint on the economy. All of this means a lot of change. We’re looking at a lot of positives ahead, but suffice it to say that any inflection point means things get more complicated.” The Atlantic Trust Asset Allocation Committee recommendations express our views on directional portfolio shifts driven by an assessment of relative risk and reward and do not take into consideration individual suitability requirements. At Atlantic Trust, asset allocation may be customized for each client, so a client’s particular portfolio allocation may not follow these recommendations. Some recommendations referenced may not be appropriate for your specific situation, so you should consult with your financial advisor regarding your unique circumstances. 1 Bureau of Labor Statistics, 10.31.2016. 2, 4 Wonkblog, washingtonpost.com, 11.30.2016. 3 “Trump’s trade talk breeds worry among U.S. firms,” USA Today, 11.30.2016. 5 ”Global Aerospace and Defense Sector Poised to Resume Growth,” deloitte.com.
With all that is going on from a political and capital markets perspective, how should we be thinking about our asset allocation?
Bradley Fincher Senior Vice President, West Palm Beach and New York As always, you should have a strategic allocation, focusing on your long-term goals, while including an appropriate mix of tactical and opportunistic asset classes. Our Asset Allocation Committee works as a team to build asset allocation recommendations. Those recommendations are then monitored and updated as the capital markets evolve. This may include a more protective stance, an opportunistic strategy or a combination of both. Where appropriate, portfolios are then customized at the individual account level.
Wanda G. Colburn Managing Director, Denver and Boston The Republican sweep has significant implications for economic and tax policy. While the general trend is discernible, the implementation still needs to be ironed out. At the margin, domestic stocks should be favorable and we expect bond positions will become more defensive. Further portfolio changes will become more targeted as the details emerge.
Q1 Q12017 2017
Estate Planning Post-Election:
Goodbye Estate Tax?
liminate the estate tax”—those four words are getting a lot of attention now that we’re past the election and President-elect Donald Trump’s campaign platform will begin to be shaped by a GOP-controlled Congress. But repeal of the estate tax is just one part of Trump’s tax platform, with significant changes proposed to the rates of individual and corporate taxes, long-term capital gains and qualified dividends, along with changes to allowable deductions and the step-up in basis.1 “From a planning standpoint, these are all interrelated,” says Darren M. Wallace, Esq., a partner with Day Pitney LLP. “None can be examined in a vacuum. And, of course, much is unknown at this point about what will become reality and when. We’re likely to see some creative legislative solutions to achieve tax reform and account for the lost revenue to the government.” [Please see page 10.] Could the proposed repeal of the estate tax be a one-fell-swoop deal retroactive to January 1, 2017, could it wait until 2018 with income tax and corporate tax relief a higher priority, or could it be phased out over years? There’s certainly precedent for a phaseout. President George W. Bush eliminated the estate tax with a “sunset” provision in 2001, as part of the budget bill that year, which also included a gradual increase in the exemption over the next 10 years. It turned out to be a temporary repeal, however, as the estate tax was resurrected in 2011. A significant unknown is what might replace the estate tax—Trump’s proposal includes a 20% capital gains tax at death on transfers of more than $10 million.2 “This is a real possibility,” says Wallace. “An open question is whether shifting assets out of an estate into an irrevocable trust would avoid triggering this possible capital gains tax. In addition, since the estate tax was permanently re-enacted in 2012 with a $5 million exemption indexed
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Wealth Strategies for inflation, we’ve seen a shift to planning with more of a focus on income taxes as those rates have crept up. Planning to minimize income tax consequences at death may continue if the estate tax is eliminated again, even if income tax rates are lowered.” Also unknown is whether the gift tax will be repealed. If it is, it will be “open season” for transfers, says Wallace. “Without a gift tax, a parent could, for example, gift an interest in a business to a child, who would pay the income tax at possibly a lower rate than the parent, and the child later could gift the interest back to the parent. There also would be no impediment to funding a long-term dynasty trust. Eliminating the gift tax removes a significant hurdle that could allow for unfettered transfers of assets among family members to achieve any number of purposes. There may be a very good reason to do that transfer with a gift tax in place, which now taxes total lifetime gifts over $5.49 million at 40%, but if the tax is eliminated, that additional consideration will be gone.” For many high net worth individuals, existing estate plans have been created as tax-driven strategies. With the possibility of no estate tax, certain language in trusts could lead to confusion—and unintended consequences. “Let’s say that the trust document specifies that at death the ‘greatest amount of assets that will not trigger an estate tax goes to this beneficiary and the rest goes elsewhere.’ Without the estate tax, that could create a significant unintended skewing of how assets are allocated at death, or a situation in which the allocation of assets is unclear due to ambiguities in the document,” says Wallace. “Now may be the time to revisit planning and focus on this possibility to make sure the intentions of the plan are still sound before and after possible elimination of the estate tax. Certain clients may even need to have contingencies in their plans— essentially, ‘if this, then that.’”
President-elect Trump has also proposed to eliminate charitable deductions for contributions of appreciated assets into a private foundation. Proposed changes to individual income taxes also include limiting deductions (to $200,000 for a married couple).3 So, for charitably inclined clients, accelerating charitable contributions, and therefore charitable deductions, and forming a private foundation probably should be considered sooner rather than later, when the benefit of charitable deductions could be lower.
Life Happens— With or Without Tax Changes It’s logical for clients to want to take a “wait and see” approach to estate planning during this period of unknowns about reform. While that makes sense for some strategies, it’s important to remember that life happens—children come of age, businesses break up, couples get divorced, people suffer disabilities, people get remarried—and estate planning should happen, too, says Halsey O. Schreier, vice president and wealth strategist in Atlantic Trust’s New York office. “It’s difficult to provide definitive advice given the uncertainty of the estate tax, gift tax and GST tax, so we’re talking with clients about the long-standing reasons for sound planning,” says Schreier. “You most certainly can use existing estate planning tactics effectively while living with the unknown. For example, a non-tax planning aspect is the creditor protection offered by trusts and the control a trust can give over an inheritance. Trusts for children to receive money at young adult ages really act as more of a shield, a sense of security for both parties, rather than a sword, and can be effective regardless of the tax environment. That sense of security can also be valuable if an aging family member shows signs of diminished cognition. It makes good sense to put these types of strategies in place at almost any time.”
Most important, says Schreier, is that while the tax environment has always contributed to clients’ getting their estate plans done, now more than ever, the reason clients move forward with plans is the desire for legacy. “People have lived through the environment of a high estate tax, a phased-out one and a lower re-enacted one. For a lot of clients, this has meant simply focusing on the tried and true: How do we protect our assets, plan for our legacy and educate our children about stewardship given an often-changing environment regarding tax reform? So, while we do get questions about what may happen, the conversation usually evolves into those fundamental and very important goals.” There may be no rush to do new planning given the various possibilities on timing of reform, but clients should make sure the basics appropriate for them are in place— wills, powers of attorney, basic trusts. If they are in place, now is a good time to review them. Similarly, now may not be the time to undo basics that have been put in place previously—such as drop a life insurance policy that was purchased to pay a client’s estate tax. Remember that previous “permanent” repeal of the estate tax and that it came back? “Estate planning is largely about passing assets in an organized and thoughtful fashion to the next generation or to your charitable beneficiaries,” says Schreier. “The moral of the story right now is: ‘Don’t let the tax tail wag the estate planning dog.’ We’re going to hear and read an awful lot during the next several months about which way tax reform is going. You should try not to get too focused on that. Taxes come and go. Good estate planning will always be needed—regardless.” 1 “Details and Analysis of the Donald Trump Tax Reform Plan, September 2016,” taxfoundation. org, 09.19.2016. 2, 3 “The Candidates’ Tax Proposals Viewed Through a Philanthropic Lens,” wealthmanagement.com, 10.14.2016.
TAX REFORM: What, When and How The possibility of significant tax reform has been on the minds of many ever since November 8, when Donald Trump was elected president. Changes to tax law were a primary campaign pledge and an ocean of ink already has been spilled on what it might mean for businesses, individuals and the economy as a whole. But what, when and how are the most pressing questions on many clients’ minds. We went to Daniel Clifton, a partner with Strategas Research Partners in Washington, D.C., for his expert analysis of what’s likely to happen. According to Clifton, an all-Republican government means a 75% probability of tax reform taking place. But there are three big questions that will impact the size, scope and timing of any tax reform package: (1) Will Congress move the tax reform package on a partisan basis or seek bipartisan cooperation? (2) Will Congress move on tax legislation in one or two steps? (3) Will the revenue estimators use dynamic or static scoring? Here’s how Clifton breaks those down.
Partisan or Bipartisan Tax Reform?
The choice on this question will have an outsized effect on what can and cannot get done legislatively. Under normal rules, 60 votes are needed to pass legislation in the Senate. With Republicans holding just 52 seats, at least eight Democratic votes will be needed to pass tax reform, which could be achieved, as many Democrats believe the tax system is in need of reform. Moreover, 10 Democrats are up for reelection in 2018 in states that Trump won—Pennsylvania, Indiana, North Dakota, West Virginia, Missouri, Florida, Michigan, Montana, Wisconsin and Ohio. If a bipartisan package does move through the Senate, these will be the key senators to watch. We believe Senate Republicans will try the bipartisan route, but will eventually fall back to the messy budget reconciliation process that requires just 51 votes. To achieve tax reform through the budget reconciliation process, any increase in the deficit from the package would require the provisions to be temporary.
Timing of Tax Cuts and Tax Reform YEAR
REFORM OR CUT
DATE OF PASSAGE
One-Step or Two-Step Tax Reform?
Tax reform, which we define as the lowering of tax rates and broadening of the tax base, is a very difficult and time-consuming process. Cutting tax rates is a much quicker process than tax reform, which lowers tax rates but also removes tax deductions and credits. It took President Ronald Reagan nearly two years to complete the Tax Reform Act of 1986 despite winning 49 out of 50 states in the 1984 election. House Republicans generally believe this should be a one-step process, with individual and corporate tax reform taking place together, but this probably makes a bipartisan process harder, given the Democrats’ focus on income inequality. A two-step process would consist of corporate tax changes followed by individual changes. This could get a fiscal policy deal in place quickly, allowing the Federal Reserve to normalize monetary policy more quickly and easily. Republicans initially may be reluctant to go the two-step route, but we believe the administration will push this approach and succeed.
Dynamic or Static Scoring?
Dynamic scoring gives lawmakers a tool to evaluate the trade-offs in tax reform. House tax reform plans no longer score $1 of tax cuts as $1 of revenue loss to the federal government and now account for the economic growth effect of tax cuts. This is not saying that tax cuts pay for themselves. Rather, the process says that tax cuts don’t cause as much lost revenue if higher levels of growth are taken into account. Dynamic, rather than static, scoring requires fewer offsetting tax increases for tax reform—it allows the severity of the tax increases to be moderated. House rules permit dynamic scoring, but the Senate’s do not. Senate staff will likely get around this by writing into the budget resolution that the Senate parliamentarian must use dynamic scoring. Watching this development as part of the budget debate will be critical since without dynamic scoring, crafting a tax reform package will be more difficult.
Once we learn the answers to these three critical questions, we will have a better idea of the size, components and timing of the tax package. And that is when the real work begins: understanding the size of potential tax rate cuts and the potential offsetting deductions and credits needed to pay for tax reform.
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Bigger Things Might Come in Smaller Packages The outlook for small-cap stocks is the most promising it has been in a decade. There are many reasons to say about last year, “What a November!” One of those reasons is that small-cap stocks saw their best November on record, dating back to 1979, and best “margin of victory” over large caps since 2002: The Russell 2000 Index gained 11.2% in November vs. gains of 3.9% and 3.7%, respectively, for the large-cap Russell 1000 Index and S&P 500 Index.1 This is certainly a noteworthy divergence, according to Bryan G. Reilly, senior vice president and senior investment analyst in Atlantic Trust’s Boston office. “The last decade has been pretty uninspiring for this segment,” says Reilly. “During this period, it was more of an advantage to be in mid- and large-cap stocks, which generally delivered better returns with lower risk than small-cap stocks. From about 2004 until recently, small-cap stocks generally were expensive relative to large caps. But in the summer of 2016, small caps went to a discount for the first time in more than 10 years. And then came November and the election, and small caps had a strong showing, which we believe is likely to continue as we move into 2017.”
“Small businesses are in all sectors
Because of small caps’ relative performance and valuations, the Atlantic Trust Asset Allocation Committee (AAC) had only a small allocation to small caps until recently. At its late November meeting, the AAC increased the recommended allocation for both small caps and mid-caps, and decreased the recommended allocation for developed international stocks. The AAC continues to believe that large-cap stocks should form the core of most investors’ equity portfolios due to a propensity for diversified revenue streams and strong balance sheets. “But,” says Reilly, “we think anticipated changes to economic policy are likely to improve the outlook for small caps. We hadn’t found small caps very appealing for quite a while. Now, we believe that for a period of probably 12 to 18 months, they have a significantly improved outlook.”
of the economy and may have been
Drivers of Small-Cap Performance
around for as long as 20 years,
Small companies—about 28 million, according to the Small Business Administration—are the backbone of the U.S. economy; since the 1970s, small businesses have provided 66% of all net new jobs. 2 “The companies in the Russell 2000 are
but many have struggled since 2008. They should expect better times ahead.”
Investments Inflation (CPI) vs. Large/Small Performance not the mom-and-pop dry cleaners down the street. Typically, they are companies with market values between $300 million and $2 billion,” says Reilly. “They’re not micro-caps, which means they’ve probably survived for a while, and they typically have reasonably good business models. But they’re in all sectors—consumer discretionary, technology, aerospace and defense, banking. They deliver flowers, sell clothes, make steam generators, build homes. Some of these companies have been around for as long as 20 years, but many have struggled significantly since the recession of 2008. The good news is that they should expect better times ahead.” Three important policy changes expected from the incoming administration are contributing to the upgraded outlook for small-cap stocks: a strengthening U.S. dollar, the possibility of rising inflation and corporate tax reform. When the dollar strengthens, small- and mid-cap stocks tend to outperform largecap and international stocks. The median performance of the S&P 400, which consists of mid-caps, was 17.7% during periods from January 1991 to November 2015 when the U.S. dollar strengthened, while the Russell 2000 median performance was 15.2%.3 “Compare that to the median performance of the S&P 500 during these same periods: 5.9%,” says Reilly. A stronger dollar can be a headwind for large companies with global operations— it hits both the top line of sales and the bottom line of profitability because foreign operations are translated back into the U.S. dollar. Most small-cap companies operate predominantly in the U.S.—as a group, small-cap companies generate 19% of their revenues from international sources (although many operate solely in the U.S.), vs. 31% for the S&P 500 companies—and they should benefit more from policies designed to strengthen the U.S. economy, avoiding turbulence or low-growth patterns internationally.4
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Small TR Index vs. Large TR Index (left-hand side) 6 5 4 3 2 1 0
YoY CPI (right-hand side) 16% 14% 12% 10% 8% 6% 4% 2% 0% -2% -4%
Source: CRSP, BLS.
The possibility of rising inflation is another important metric for evaluating smallcap stocks’ outlook. While it’s not true all the time, smaller-cap stocks tend to outperform when inflation is rising. [See chart above.] From 1974 to 1983, for example, small caps outperformed as inflation rose, and it occurred again from the late 1990s to about 2005. Corporate tax reform looks to be a high priority—and not a moment too soon as far as U.S. companies are concerned. High taxes make U.S. companies less competitive globally. Of the countries that make up the G20, the U.S. and Argentina have the highest federal corporate tax rate (35% currently), with the lowest being 20%.5 Based on five-year averages, smallcap stocks have averaged an effective tax rate of 33.5%, while large caps have averaged 30.1%.6 “Corporate tax reform would benefit small-cap stocks,” says Reilly. “These companies have less flexibility than large companies to shield their income from taxes.” An analysis done by Jefferies LLC, a global investment banking firm based in New York, of how cutting corporate rates would affect earnings growth of small companies indicates that the 2017 earnings growth rate for small caps would jump from 14% to 37% under a 22% top tax rate and to 49% under a 15% top tax structure. Even though the tax rate change may not take effect
in 2017, once enacted, companies would have much better cash flow and would be better positioned to reduce shares, increase dividends and spend on capital projects.7 A final possible policy change that could affect small-cap stocks is President-elect Donald Trump’s vow to impose new tariffs on other countries’ goods coming into the U.S. “That’s not a pro-growth position,” says Reilly, “and it would probably hurt many U.S. companies and individuals. But smallcap stocks might be hurt less than the multinationals that make up the S&P 500. Despite some uncertainty, economic indicators postelection have shown that confidence and business activity have ramped up, according to Reilly. “As long as valuations are in check during a growing economy, it can be a boon for smaller companies.” 1 “Small-Caps Enjoy Their Best November Yet,” Seekingalpha.com, 12.06.16. 2 sba.gov. 3 Strategas Research Partners. 4 U.S. Equity Strategy, Credit Suisse, 12.07.2016. 5, 6, 7 Strategy Note, USA Equity Strategy, Jefferies LLC, 11.21.2016. The Atlantic Trust’s Asset Allocation Committee recommendations express our views on directional portfolio shifts driven by an assessment of relative risk and reward and do not take into consideration individual suitability requirements. At Atlantic Trust, asset allocation may be customized for each client, so a client’s particular portfolio allocation may not follow these recommendations. Some recommendations referenced may not be appropriate for your specific situation, so you should consult with your financial advisor.
Takeaway Taking Advantage of Delaware’s Trust Laws on Decanting Existing Trusts Delaware has long been a jurisdiction of choice for grantors of trusts due to its trust-friendly body of legislation and system of case law supporting favorable provisions that clients put in place with their Delaware estate planning. How can Delaware benefit client families? One way is through the ability to decant an existing irrevocable trust. “A client’s original Delaware trust was created and funded as an integral part of a broader estate plan designed to benefit subsequent generations of the family. Over a relatively short period, the dynamic needs of the family evolved and the various benefits of the original trust were reduced. Some family members moved outside the U.S., changing residency and citizenship status. The family also wanted to add a new trustee with close ties to the family in the new domicile. Additionally, tax treatment of income and certain reporting would be more complex under a different tax system. Finally, the family’s business interests created a need for greater flexibility than was provided within the original trust. We were able to take advantage of the Delaware decanting statute to help the family create new trusts that would better meet their changing needs.” – Thomas N. Riley, CFA, managing director, senior relationship manager and head of the Atlantic Trust Boston office
DECANTING STATUTE THE BENEFIT?
Generally, the provisions of irrevocable trusts may not be amended. Delaware has implemented a process whereby the assets of a trust that no longer meets the grantor’s purposes may be transferred to a new trust that meets changing circumstances.
WHO CAN BENEFIT?
Clients with existing trusts that no longer meet the needs of the beneficiaries, for example, clients with family situations that have changed since the creation of an older trust.
QUESTIONS TO CONSIDER?
n n n
Have you created trusts for your family members? Do the terms of distribution of those trusts still meet the purpose you intended? As children and grandchildren have gotten older, do you feel that they may benefit more from different trust provisions?
“The Delaware decanting statute allowed our client the flexibility to select a trustee in tune with his family’s needs, which the original document would have prohibited. The client was the beneficiary of a trust created in Delaware by his father, and although the trust granted him the power to change trustees, the definition of an allowable trustee was antiquated and restrictive, and would not permit him to name the trustee he wanted. Using the decanting statute, the trust assets were transferred into a newly drafted trust with the same terms, but with updated administrative provisions, including a more modern definition of an allowable trustee. The new trustee is now administering the trust in concert with the client family’s other assets, and with a greater understanding of the family’s overall wealth picture.” – W. Scott Thompson III, managing director, senior relationship manager and head of the Atlantic Trust Atlanta office For more on the benefits of a Delaware trust, visit atlantictrust.com for our Atlantic Trust Company of Delaware video overview and white paper series.
Atlanta 404 881 3400 Austin 512 651 7800 Baltimore 410 539 4660 Boston 617 357 9600 Chicago 312 368 7700
New York 212 259 3800 Dallas 214 459 3411 Denver 720 221 5000 Houston 832 941 5760 Newport Beach 949 660 0080
San Francisco 415 433 5844 Washington, D.C. 202 783 4144 West Palm Beach 561 515 6043 Wilmington 302 478 4050
Atlantic Trust Private Wealth Management includes Atlantic Trust Company, N.A. (a limited-purpose national trust company), Atlantic Trust Company of Delaware (a Delaware limited-purpose trust company), and AT Investment Advisers, Inc. (a registered investment adviser), all of which are wholly-owned subsidiaries of Atlantic Trust Group, LLC. This document is intended for informational purposes only, and the material presented should not be construed as an offer or recommendation to buy or sell any security. Concepts expressed are current as of the date of this document only and may change without notice. Such concepts are the opinions of our investment professionals, many of whom are Chartered Financial Analyst® (CFA®) charterholders or CFP® professionals. Certified Financial Planner Board of Standards Inc. owns the certification marks CFP® and CERTIFIED FINANCIAL PLANNER™ in the U.S. There is no guarantee that these views will come to pass. Past performance does not guarantee future comparable results. The tax information contained herein is general and for informational purposes only. Atlantic Trust does not provide legal or tax advice, and the information contained herein should only be used in consultation with your legal, accounting and tax advisers. To the extent that information contained herein is derived from third-party sources, although we believe the sources to be reliable, we cannot guarantee their accuracy. Approved 767-16. For Public Use. Investment Products Offered are Not FDIC-Insured, May Lose Value and are Not Bank Guaranteed.