Wishing you a healthy, happy, and prosperous new year.
Yogi Berra once famously said: “The future ain’t what it used to be.” So true. Amazon announced this month that purchases could be delivered to your doorstep by drones in a few years. And, it’s very possible that you won’t pay for them with U.S. dollars. You might be using Bitcoin, the new virtual currency.
Bitcoin (“BTC”) has soared into public attention this year as its price went from $15 in January to over $1,000 in early December. Actually, the basic concept of Bitcoin, a currency independent of governments and banks, dates back over 80 years to Thomas Edison. Mr. Edison not only was granted 1,093 patents, but he also was weighed in on economic issues. After World War I there were wide fluctuations in the value of the dollar and rampant inflation in much of the world. Mr. Edison distrusted banks and proposed a new monetary system using commodities as the underpinnings for a new currency. He and his friend Henry Ford called it “Ford-Edison Commodity Money.” The idea was ahead of its time and didn’t catch on.
Fast forward to 2009. BTC software is developed by Satoshi Nakamoto (a pseudonym). It allows users to send payments within a decentralized, independent peer-to-peer network. It does not require a financial institution or central clearing house. Users simply need an internet connection and the BTC software to make and accept payments.
BTC fulfills some of Edison’s concepts:
- It is backed by commodities- energy and time
- The BTC network stores the transaction history inside a log called the “blockchain” which constantly grows as new records are added and never removed. Though these are today cloud based, they are similar in concept to Edison’s proposed “commodity warehouses.”
- It is (theoretically) inflation-proof
Early adopters have been computer geeks, libertarians, drug dealers and others world-wide. Now, BTC is attracting some surprising new fans. Fed Chairman Ben Bernanke said last month that it “may hold long-term promise.” A small but growing band of stores and companies are accepting payment in BTC, particularly internet companies in China. However, on December 5th, the Chinese government central bank effectively halted the use of BTC for Chinese business-to-business monetary exchange. BTC prices dropped 30% the following day.
Coincidentally, on December 5th, Bank of America Merrill Lynch became the first major financial institution to initiate analyst coverage of BTC. Their report started with the following: “We believe Bitcoin can become a major means of payment for e-commerce and may emerge as a serious competitor to traditional money transfer providers. As a medium of exchange, BTC has a clear potential for growth, in our view.” Further, they suggested that BTC will likely only have a limited role in black market/underworld transactions, since all transactions are public and every BTC has a unique transaction history that can’t be altered. BOA’s report also provided a valuation of BTC assuming it becomes a major player in e-commerce and a significant store of value (perhaps like silver). The report set the maximum value on one BTC at $1,300.
BOA also provided a nice recap of the advantages and disadvantages of BTC:
- As a medium of exchange, it offers low transaction costs
- As an alternative for cash, it has better security and more transparency of transactions
- There is a finite supply of BTC
- Its anonymity is advantageous to those in countries wanting to avoid controls or confiscation
- It’s the first digital currency and while there will be others, it’s the current leader
- For asset allocation purposes, it has a low or even negative correlation with the stock market
- Its price volatility limits its role as a store of value
- Regulators could impose controls over transaction costs
- The quality of BTC exchange security is suspect. Hence, Bitcoin users/investors may be subject to both investment risk and credit risk.
- Governments may halt or limit the use of BTC
- It is not a legal tender- no one is required to accept them. Hence, its value is only as good as the perception of its worth. And, it is not a publicly traded security.
Bitcoin could become very important in the coming years. Or some other “cryptocurrency” may take its place. However, as Yogi also said, “it’s tough to make predictions, especially about the future.” Either way, we’ll be watching and reporting on the new phenomenon of digital currency as it plays out. Very exciting.
As part of our monthly series of spotlighting one of our Liquid Alternatives preferred holdings, I would like to provide some color on the AQR Managed Futures Mutual Fund (symbol: AQMNX). There are a few different ways to get exposure to managed futures. We think the best liquid and cost-efficient way to do so is by using a single manager option vs. a multi-manager option, which means there are not multiple layers of fees. Although this fund is managed systematically, the firm’s principals have been managing trend-following strategies for institutional clients since the mid-1990s. We are big fans of the managers who have some of the best alternative experience in the business. AQR was founded in 1998 and is headquartered in Greenwich, CT, and also have satellite offices in Chicago, London, and Sydney. I personally visited their Chicago offices and was very impressed with everything, particularly the culture. Their philosophy and approach is deeply grounded in empirical finance research.
Managed futures investing is an alternative investment strategy in which portfolio managers look to profit from identifying short and/or long term trends via the use of future contracts. Introducing futures into a portfolio reduces risk because of the negative correlation between asset groups.
This managed futures fund invests in commodities, equities, currencies, and fixed income – they gravitate to the spot where the research is identifying the best trend. They also work in both short-term trends (one to three months) and long-term trends (up to 12 months). Both long and short positions are employed. Of course, we think the best part of this strategy is the non-correlation it brings to the table which ultimately offers more protection to your overall portfolio should the stock market fall off. If stocks head south, this fund has no correlation and is doing its own thing. In 2008 when stocks got torn apart, managed futures was one of the only strategies that really excelled. With the equity bull market being “long in the tooth” and with fixed income not the most attractive place to be right now, we really like holding this position within our Liquid Alternatives Model and clients’ portfolios.
Again, alternatives provide an additional asset class that can produce new sources of returns with lower correlation and reduced volatility. We expect volatility and returns for the alternative portion of one’s portfolio to be somewhere between what you would expect of stocks and bonds, with an extra bonus emphasis on downside protection. We continue to watch this exciting area of investment management for continued opportunities and use this forum as an educational tool.
Please don’t hesitate to reach out to the DWM team if you have a particular question on liquid alternatives and/or just want to say ‘Hi’!
“You can always extend April 15th (filing date) but you can’t extend December 31st (end of the year).” That’s a favorite saying of many CPAs I know. It’s the reason it is so important to work with your CPA and look at your tax situation in December, make decisions and implement those items that have to be done before we all start singing “Auld Lang Syne.” You may still be able to lower your 2013 tax bill.
Yes, the top 1% of taxpayers will be hit by much of this year’s tax increases, but those people with adjusted gross income (“AGI”) between $150,000 and $500,000 may also be hit. Some key changes are the net investment income tax (“NIIT”) and the personal exemption phase-out (“PEP”).
NIIT came about as part of the health-care overhaul. The tax is an additional 3.8% on the net investment income of most couples with AGI over $250,000. PEP has returned after a three year absence and can limit itemized deductions and exemptions. PEP can effectively add a 1% or more surcharge to taxpayers.
Taxes have, again, gotten more complicated. You really need to start by looking at your potential tax bill, including a check of AMT. We encourage you to work with your CPA and take advantage of their experience, their knowledge of your situation and their software to make these calculations and provide input as to the impact of potential strategies.
Some of the tax items that should be reviewed before year-end:
- Payment of real estate, income and sales taxes by year-end or not
- Health Savings Account contributions
- Purchase of equipment for a business- Section 179 write-offs are scheduled to be phased back substantially in 2014
- Charitable contributions- cash and/or appreciated securities
- Required Minimum Distribution from your IRA (if over 70 ½)
- Roth Conversion- all or part of your IRAs
- Energy Credits
- Electric Vehicles
- Teachers’ Deduction for Certain Expenses
- Contributions to Retirement Plans and IRAs (in some cases, plans need to have been established by 10/1/13 and in some cases contributions can be made in 2014).
- Contribution to a non-deductible IRA and then conversion to Roth (“Back-door Roth”)
- Capital gains and losses- you may want to harvest losses or harvest gains, depending on your circumstances
- Make lifetime and/or annual gifts. Couples can give $28,000 in 2014 to each donee using their annual gift amount.
- Maximize medical and miscellaneous deductions
A number of the above are set to expire on 12/31/13. Last chance.
We would like to put in a “plug” to consider Roth conversions. As you know, retirement accounts and IRAs are generally funded with pre-tax dollars and grow without tax. However, the IRS is your silent partner on these. They get their tax when the funds are distributed, either during your life or your beneficiaries’ lives. A taxpayer can convert an IRA or part of an IRA to a Roth and pay the tax due then. From that point forward, the Roth account grows without tax and without a requirement for regular distributions at age 70 ½ and beyond. It can become a wonderful legacy for the family and/or a great tax-free investment vehicle for an investor. We have a number of clients who annually convert an amount from their IRA to their Roth and build the Roth account. Of course, this strategy is not for everyone, but it should be considered at year-end.
So, between all the holiday festivities in December, you’ve got some homework to do. Get with your CPA and review your 2013 taxes and see if you can lower them. And, if you have questions about Roth accounts or conversions, give us a call.