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2024 Curriculum CFA Program Level III Portfolio Management and Wealth Planning


This reading focuses on three important areas of technical competency in the management of private client assets: the impact of taxes on wealth accumulation, the management of concentrated positions in public or private assets, and basic tools and techniques for preserving wealth through generations.

We begin with a discussion of taxes. Taxes are an important determinant of the taxable investor’s final returns. While fees and trading costs have received a lot of attention in the press and academic spheres, the erosion of returns due to taxes can be much more significant.

Consider this scenario: After significant development and testing, your firm has just launched a new strategy that tactically shifts between different equity indexes. The backtests show significant alpha over most time horizons and especially strong performance during market downturns—a risk/return profile that should be highly attractive to your clients. You launch the strategy 1 January, and everyone is pleased with the performance in the first year. On 15 February of the following year, the founder of the firm receives a telephone call from the accountant for Charles and Ivy Lee, an important private client relationship. The accountant has been compiling the Lees’ tax documents in preparation for filing the annual tax return. It seems that the trading activity inherent in your new strategy has generated a lot of capital gains, and the resulting tax bill is larger than the excess returns generated by your strategy!

This scenario is not uncommon. Because a significant proportion of actively managed assets is managed on behalf of tax-exempt institutions, such as retirement plans and sovereign wealth funds, strategies are often developed either without regard to taxes or with taxes as an afterthought and then applied—unsuccessfully—to taxable investors.

To illustrate the effect of taxes on wealth accumulation, let’s examine a longer time horizon. The S&P 500 Index from 1 January 1990 through 30 June 2019 appreciated 7.5% per year, on average. With dividends reinvested and ignoring fees and transaction costs, the compound annual growth rate would have been 9.8%. If the Lees had invested $1 million on 1 January 1990, we would expect their portfolio to have grown to $16 million by the end of the nearly 30-year period. However, this is only true if the assets are not subject to taxation during the accumulation phase, as would be the case if they are held in a retirement account or a private family foundation.

If we assume the worst case, that both dividends and capital gains are taxed fully at a marginal tax rate of 50%, then the 9.8% compound annual growth rate would be cut roughly in half—to 5.0%. In other words, their $1 million would have only grown to $4 million after almost 30 years—only one-fourth of what the tax-exempt account realized. Clearly, taxes are an important investment consideration.

Fortunately, as a tax-aware practitioner, you may be able to use various tax-management techniques to reduce the tax drag. If capital gains and dividends are taxed at 25%, the final wealth of the taxable portfolio would have grown to $8 million. If capital gains taxes can be eliminated or deferred and only dividends are taxed at the 25% rate, then the $1 million would have grown to $13 million at the end of our horizon. It is still not as good as the tax-exempt case, but it is significantly better than our worst case.

Broadly speaking, a portfolio manager managing assets for a private client looks to maximize after-tax returns for a given level of risk. This reading lays the ground work for understanding how different types of taxes impact wealth accumulation. We review the general principles of taxation, how to measure tax efficiency, and how to reduce the impact of taxes on a portfolio.

Hopefully we’ve convinced you why it is important to manage your client’s portfolio with taxes in mind. Tax considerations, however, are just one element of managing assets for private wealth clients. Suppose that only 50% of your private client’s assets are invested in your tax-aware investment strategy. The other 50% of assets are tied up in a company that was the primary source of wealth creation for your client: Ivy Lee started a business in her early 20s that succeeded far beyond her initial expectations. While she has accumulated liquid assets outside of that business, a substantial portion of her net worth is held in company stock. From your earlier readings in the course of the CFA Program, you realize that this is a very risky position. Taken in the aggregate, her portfolio is undiversified; however, to sell the position outright would create an enormous tax liability or lead to a loss of control over the business she created. How, then, do you help the client achieve her goals? This reading discusses some practical tools that you can employ to manage the risk of this concentrated position.

Finally, Ivy and Charles want to maximize the likelihood that the strong financial foundation they have created will survive to provide support for their children’s and grandchildren’s future endeavors. Ivy has frequently heard the phrase “shirtsleeves to shirtsleeves in three generations,” meaning that family wealth rarely survives beyond three generations. Some variation of that saying exists in many cultures. The Lees want your help to create a structure that will counter that conventional wisdom. While this reading won’t make you an estate planning expert, it will prepare you to identify estate planning opportunities that may help the Lees achieve that goal and to work more effectively with the Lees’ estate planning professionals toward that end.

Learning Outcomes

The member should be able to:

  1. compare taxation of income, wealth, and wealth transfers;

  2. describe global considerations of jurisdiction that are relevant to taxation;

  3. discuss and analyze the tax efficiency of investments;

  4. analyze the impact of taxes on capital accumulation and decumulation in taxable, tax-exempt, and tax-deferred accounts;

  5. explain portfolio tax management strategies and their application;

  6. discuss risk and tax objectives in managing concentrated single-asset positions;

  7. describe strategies for managing concentrated positions in public equities;

  8. describe strategies for managing concentrated positions in privately owned businesses and real estate;

  9. discuss objectives—tax and non-tax—in planning the transfer of wealth;

  10. discuss strategies for achieving estate, bequest, and lifetime gift objectives in common law and civil law regimes;

  11. describe considerations related to managing wealth across multiple generations.


Even the best private wealth manager will never have all the answers. An effective private wealth manager will, however, be in a position to ask the right questions and consult the right experts to help clients navigate an increasingly complex world. This reading covers important points for managing assets on a tax-aware basis and managing concentrated positions in real estate and private and public equities. It also provides an overview of estate planning.

  • Three foundational elements of investment taxation include: 1) taxation of the components of return, 2) the tax status of the account, and 3) the jurisdiction that applies to the investor (and/or account).

  • Many countries’ tax codes create preferential treatment for some types of dividend and interest income. Long-term capital gains are typically taxed at a lower rate than other forms of income.

  • Income from real estate investments may be reduced by maintenance, interest, and depreciation expenses.

  • Private clients often have a mix of taxable, tax-deferred, and tax-exempt investment accounts. Returns in tax-deferred and tax-exempt accounts compound using the pre-tax rate of return. Tax-deferred accounts pay tax only when assets are withdrawn from the account. Taxable accounts compound using the after-tax rate of return.

  • Broadly speaking, countries may operate under one of three tax regimes: tax havens, territorial tax systems, and worldwide tax systems. A tax haven has no or very low tax rates for foreign investors. A territorial regime taxes only locally-sourced income. A worldwide tax regime taxes all income, regardless of its source.

  • The Common Reporting Standard exists to ensure exchange of financial account information to combat tax evasion. The United States uses FATCA, the Foreign Account Tax Compliance Act, for the same purpose.

  • Equity portfolios are often more tax efficient than strategies that rely on derivatives, real assets, or taxable fixed income. Higher-yield and higher-turnover strategies tend to be less tax efficient.

  • The tax considerations associated with alternative asset classes are more complicated than those associated with stocks and bonds.

  • Measures of tax efficiency include after-tax holding period return, annualized after-tax return, after-tax post-liquidation return, after-tax excess return, and the tax-efficiency ratio.

  • Asset location is the process for determining which assets should be held in each type of account. A general rule of thumb is to put tax-efficient assets in the taxable account and tax-inefficient assets in the tax-exempt or tax-deferred account. The actual solution may differ depending on the strategy and the investor’s horizon.

  • It is typically better to make withdrawals from the taxable account first and then from the tax-deferred accounts. Under progressive tax regimes, it may be more tax efficient to withdraw from the retirement account first until the lowest tax brackets have been fully utilized.

  • Tax avoidance is the legal activity of understanding the tax laws and finding approaches that avoid or minimize taxation. Tax evasion is the illegal concealment and non-payment of taxes that are otherwise due.

  • Tax avoidance strategies include holding assets in a tax-exempt account versus a taxable account, investing in tax-exempt bonds instead of taxable bonds, holding assets long enough to qualify for long-term capital gains treatment, and holding dividend-paying stocks long enough to pay the more favorable tax rate. Tax-deferral strategies include limiting portfolio turnover and the consequent realization of capital gains and tax loss harvesting.

  • The structure of the investment vehicle in which a client’s assets are held may affect the tax liability and the adviser’s ability to manage the client portfolio in a tax-aware manner. In a partnership, the income, realized capital gains, and realized capital losses are passed through to the investors, who are then responsible for any tax liability. In a mutual fund, the income and realized capital gains (but not losses) are passed through to the investors. The taxation of capital gains varies by jurisdiction.

  • Potential capital gain exposure (PCGE) can be used to gauge the amount of tax liability embedded in a mutual fund.

  • Exchange-traded funds are very tax efficient. Separately-managed accounts offer the most flexibility for tax management.

  • Tax loss harvesting is a technique whereby the manager realizes a loss that can be used to offset gains or other income. Tax loss harvesting requires diligent tax lot accounting.

  • Common methods of tax lot accounting are first in, first out (FIFO); last in, first out (LIFO); and highest in, first out (HIFO).

  • A concentrated position subjects the portfolio to a higher level of risk, including unsystematic risk and liquidity risk. Approaches that can be used to mitigate the risks of a concentrated position include sell and diversify; staged diversification; hedging and monetization strategies; tax-free exchanges; tax-deferral strategies; and estate and tax planning strategies, such as charitable trusts, private foundations, and donor-advised funds.

  • A completion portfolio is an index-based portfolio that when added to the concentrated position, creates an overall portfolio with exposures similar to the investor’s benchmark.

  • Equity monetization refers to a group of strategies that allows an investor to receive cash for a stock position without an outright sale. The investor can hedge a part of the position using a short sale, a total return swap, options, futures, or a forward sale contract and then borrow against the hedged position. The loan proceeds are then invested in a diversified portfolio of other investments.

  • Donating the appreciated asset to a charitable remainder trust allows the shares to be sold without incurring a capital gains tax. The trust can then build a diversified portfolio to provide income for the life of the beneficiaries.

  • Strategies to free up capital concentrated in a privately-owned business or real estate include a personal line of credit secured by company shares, leveraged recapitalization, an employee stock ownership plan, mortgage financing, and a charitable trust or donor-advised fund.

  • Estate planning is the process of preparing for the disposition of one’s estate upon death and during one’s lifetime. Objectives of gift and estate planning include maintaining sufficient income and liquidity, achieving the clients’ goals with respect to control over the assets, protection of the assets from creditors, minimization of tax liability, preservation of family wealth, business succession, and achieving charitable goals.

  • An estate tax is the tax on the aggregate value of a deceased person’s assets. It is paid out of the estate. An inheritance tax is paid by each individual beneficiary. A gift tax is paid on a transfer of money or property to another person without receiving at least equal value in return. Many jurisdictions have tax-free allowances that can be used for transferring assets under a certain threshold without paying an estate or inheritance tax.

  • A will outlines the rights others will have over one’s property after death. Probate is the legal process to confirm the validity of the will.

  • Common law jurisdictions give owners the right to use their own judgment regarding the rights others will have over their property after death. Many civil law countries place restrictions on the disposition of an estate, typically giving certain relatives some minimum share of the assets.

  • Common estate planning tools include trusts, foundations, life insurance, and companies. A trust is a legal relationship in which the trustee holds and manages the assets for the benefit of the beneficiaries. A trust can be either revocable or irrevocable. An irrevocable trust generally provides greater asset protection from creditors. A foundation is typically established to hold assets for a specific charitable purpose. The founder can exercise some control in the administration and decision making of the foundation.

  • Life insurance and other forms of insurance can be used to accomplish estate planning objectives.

  • Companies—specifically, a controlled foreign corporation—may allow the owner to defer taxes on income until the earnings are distributed to shareholders or until the company is sold or shares otherwise disposed.

  • Family governance is a process for a family’s collective communication and decision making designed to serve current and future generations. Good family governance establishes principles for collaboration among family members, preserving and growing family’s wealth, and increasing human and financial capital across the generations. A sound family governance system may mitigate many of the behavioral biases that impede effective decision making.

  • Conflict resolution can be particularly challenging in a family context. A family constitution can help wealthy families anticipate possible conflicts and agree on a common set of rights, values, and responsibilities.

  • Managing a concentrated position arising from a family business is more than just an investment issue. The private wealth adviser should be prepared to work with the client in succession planning and post-sale considerations, such as the loss of a key activity that united family members.

  • Effective estate planning requires planning for the unexpected, including divorce and incapacity.

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