It sounds like Money Management 101 now. But when 1838 Investment Advisors' decided — in the midst of the raging bull market of the '90s — to introduce its Tax Smart brand of portfolio management, it was a true innovation. In simple terms, Tax Smart seeks to maximize after-tax returns by achieving long-term rather than short-term capital gains and by harvesting losses whenever possible to offset those gains.
“Tax Smart was probably the most revolutionary idea in the separate account marketplace at that time,” says John Coyne, principal and national sales director at Brinker Capital in King of Prussia, Pa. Before that, separate accounts were more about personalized service than performance. “1838 put a weapon in the hand of the separate account marketplace that gave it a leg up on the mutual fund industry,” says Coyne, whose firm offers 1838 portfolios.
The tax-efficient portfolio approach is just one reason why 1838 is the fourth-largest separate account business after Brandes, Rittenhouse and Alliance Capital. The firm's roughly $11 billion under management comes mostly from high-net-worth individuals, but 1838's investors also include pensions, endowments and other tax-exempt institutions.
“We look for firms that can provide more than 90 percent tax-efficient returns, and 1838 does that on a consistent basis,” says Len Reinhart, chairman and CEO of Lockwood Advisors, a managed account marketer. In some years, says Reinhart, 1838 has produced more than 100 percent tax efficiency by getting a full return plus tax write-offs that can be used elsewhere.
1838's Web site provides tools to help advisors and brokers minimize the tax penalties in converting assets. Reps can enter an individual's portfolio, including cost-basis information of existing securities and unrealized gain and loss information.
The site's proprietary tax calculator crunches the numbers, rejiggers the portfolio and shoots out a list of recommended trades aimed at maximizing returns by minimizing the tax bite. “It then becomes a joint process between the advisor or broker, the individual client and us to get to the point where everyone's comfortable with the portfolio,” says John Springrose, 1838's national marketing director.
Because high-net-worth accounts can be so complicated, it's not always easy to convert an existing portfolio. “Depending on a client's needs and tax situation, 1838 might take a couple of years to ease that person into the ideal portfolio,” says Michael McCabe, an advisor at Kohlhepp Investment Advisors in West Chester, Pa.
1838 had its roots in Drexel and Co., the old Philadelphia financial firm. In 1988, Drexel's equity asset management arm became independent and took the name 1838, for the year in which Drexel was founded. Located in King of Prussia, the firm's bread-and-butter remains a large-cap core portfolio that's generally more workhorse than rocket ship.
| Percentage | |
|---|---|
| General Electric | 5.1 |
| Tyco International | 4.5 |
| AIG | 4.3 |
| Citigroup | 4.0 |
| Abbot Laboratories | 3.8 |
| Microsoft | 3.8 |
| Wal-Mart | 3.6 |
| Fifth Third Bancorp. | 3.3 |
| Eli Lilly | 3.3 |
| Intel | 3.0 |
In the early 1990s, the firm decided it couldn't distribute its products itself, so it joined forces with Prudential. The 1838 offerings are now on more than a dozen major platforms, including Salomon Smith Barney and Morgan Stanley.
Though 1838's various portfolios (including balanced and international) are often sector-neutral, the company's bets in the technology sector helped the firm's large cap core offering beat its benchmark, the S&P 500, in 1998 and 1999. But then the tech sector imploded and such 1838 holdings as JDS Uniphase, Cisco and Oracle went south.
The firm slightly trailed the S&P 500 in 2000 and fared even worse last year. 1838 lost 17.5 percent in 2001 versus an 11.9 percent drop in the S&P. “We were in the wrong capitalization area and had a slight tilt toward growth instead of value,” says Springrose. Things picked up in the fourth quarter, however, as 1838 outperformed the S&P in five of the eight sectors in which it invests.
| Trailing Performance | ||
|---|---|---|
| 3 Years | 5 Years | |
| Annualized Return | -1.97 | 11.9 |
| S&P 500 | -1.03 | 10.7 |
| Beta | 1.07 | 1.1 |
| R-Squared | 93.59 | 95.59 |
| Sharpe Ratio | 100.49 | 108.78 |
| Source: Lockwood Advisors | ||
The growth of separate accounts and growing awareness of tax efficiency bodes well for 1838. But it also means more competition. J.P. Morgan Chase and Rittenhouse Trust are making inroads in large-cap, tax-aware portfolios. Firms such as Stein Roe and Pitcairn have sizable tax-aware programs, too. And ever-changing technology means the company must be nimble to stay on the cutting edge. So far, at least, “1838 is still seen as the bellwether in the tax-efficient area,” says Brinker's Coyne.
