Editor’s Note: This article is part of a series that Rethinking65 is doing on viewpoints of industry leaders who attended the Schwab Impact 2023 conference.
There’s a megatrend unfolding in wealth management, one that will continue for the next 20 years or so and presents a massive opportunity for financial advisors, said Manju Boraiah, a senior portfolio manager with Allspring Global Investments.
That trend, which will come as no surprise to financial advisors, is a multigenerational transfer of wealth. It’s estimated that $84 trillion will change hands, with $30 trillion of that being transferred from baby boomers, Boraiah said during a presentation Oct. 26 at the Schwab Impact conference.
But what many advisors may not realize is that data is already showing the preferences and desired asset allocation of those investors who are planning transfers has been changing — they basically want to focus on holistic advice, explained Boraiah, who heads Allspring’s Systematic Edge Fixed Income and Custom SMA Investments. Allspring is the U.S.’s 11th largest provider of separately managed accounts; it focuses on customized SMAs through its Remi platform.
“It’s really more complex planning that involves ongoing tax management,” he said. “Tax planning is front and center. What’s also front and center is the concept of customizing portfolios. You want to basically maximize the tax efficiency across the entire portfolio.”
About half of the assets changing hands is in real estate and pension entitlements, and the other half is in liquid instruments, like mutual funds, ETFs and SMAs, Boraiah said, and it’s in the liquid portion where the portfolio changes are happening.
SMAs: where the action is
Estimates of the amount of assets in SMAs vary, but there’s widespread agreement that the individual assets managed by professionals in them will grow dramatically. Boraiah said the SMA market is currently at about $2.5 trillion, has been growing in double digits and is expected to nearly double in a decade.
One reason is that, unlike mutual funds and ETFs, managers can maximize tax efficiency in SMAs, he said. Another is customization: An investor can choose the investments in an SMA based on their financial goals or values (think ESG, for example), risk tolerance, tax objectives or investment horizon. The third reason, he said, is an investor with concentrated positions in ETFs or mutual funds can transition them to an SMA, where it’s much easier to diversify and realize tax savings.
One consideration is thinking through how to transition a portfolio into an SMA while minimizing the tax liability, Boraiah said. In other instances, an advisor may need to withdraw cash on a monthly or quarterly basis for a client. “So how do you do that in a systematic, tax-efficient way because you want to sell out of bonds or other securities that have a lower impact from a tax-cost perspective,” he said.
Boraiah noted about 30% to 40% of the SMA market is held in model portfolios and the other 60% is in manager-traded SMAs, where one can do customization and tax management.
SMAs break down into three broad categories, Boraiah said. One is direct indexing, where the underlying investments in an index are purchased individually in a taxable account. Second, municipal bonds are also often managed in SMAs, he said. And the third is a combination of taxable fixed income and equities or other fixed-income categories, he said.
SMAs also can be built with passive or active strategies, and Allspring offers a variety of both on its platform.
The simplest passive fixed-income strategy is a bond ladder, which basically is a portfolio of bonds maturing on different dates. “You can do this across munis, you can do it across corporates, you can do it across Treasurys,” Boraiah said.
But building a ladder in municipal bonds is tricky, Boraiah noted, “because, as you know, it’s a weird, quirky asset class. We have a million issues outstanding with 50,000 issuers. The broadest benchmark has 60,000 bonds, that’s 25,000 issuers. So, if you have to pick 20, or 40 bonds to build a ladder, right, it’s not easy, because you have to know what you’re picking.”
Allspring builds ladders using fundamental research that its team does, he said. The research team tracks 3,000 municipal issuers annually and filters that group down to a few hundred bonds. An advisor can use Allspring’s platform to be build optimized ladders based on specific criteria, such as bond rating, geography and more.
Other challenges with municipal bonds are that it can be hard to find what you want because it’s a highly concentrated market, and going in and out of munis can be costly, Boraiah noted. Allspring makes tax management a priority and sets a high threshold for systematically harvesting tax losses, he said.
Four themes for U.S. macro environment
Growth is slowing somewhat, labor market conditions are still tight, and inflation is moderating but does not appear to be going away soon, Boraiah observed. “The Fed is going to be data-driven, and they’re saying they want to wait and watch. They’ll probably keep rates on hold for the rest of the year. Maybe there will be another surprise hike in December, but the probability is pretty low,” he said.
With this backdrop, asset allocation is really critical, he maintained. As a result, he said, Allspring has been discussing four ideas with clients:
• Extend your duration in fixed income. It’s a good time to lock in higher interest rates.
• Invest in higher-quality fixed income. Defaults are going to rise, especially in high yield.
• Maximize the yield, especially if clients are on a fixed income.
• Add munis because they will bring stability to your portfolio.
Boraiah went into more detail on why adding munis is an important move. He said their correlation with Treasurys and the overall bond market is relatively low. They are also inefficient, which he believes is a positive, and their default rate is relatively low.
“The third thing is a lot of the bonds in the muni line are actually owned by retail investors. So 70% is actually retail, which means that they’re mostly buy and hold. So there’s price stability coming from munis,” he said.