John Bryson:
Hello, everyone, and welcome to the Portfolio Intelligence podcast. I'm your host, John Bryson, head of investment consulting at John Hancock Investment Management. As always, the goal of this podcast is to help investment professionals deliver better outcomes for their clients and their practice. Today is November 4, 2020, and I'm joined by Emily Roland and Matt Miskin, our co‐chief investment strategists at John Hancock Investment Management. As you may know, Emily and Matt are the architects behind our very popular quarterly capital markets outlook piece titled Market Intelligence. So it is Wednesday morning, election day plus one. Let's start with Emily. Did you get any sleep last night?

Emily Roland:
Yeah—well, it certainly was quite a busy night. I actually did go to bed at a reasonable hour as soon as I knew that we weren't going to know the results, especially in some of the key battleground states in the Midwest, I decided that a strategist needs her beauty rest and I decided to get back after it early this morning.

John Bryson:
Pretty sound strategy. I like that. Matt, how about you?

Matt Miskin:
Given 2016 was still ingrained in my mind, I did not sleep much at all. I think I got a couple hours in, but tried to start early here with Emily, looking at the markets into the open.

John Bryson:
Yep. Knowing you two, that's exactly how I expect it to play out for you, is that you'd be keeping one eye on the phone or the news screen. All right, well, let's get into it. So what happened last night? Maybe we'll start with Emily. Where do we stand on the presidential race and the Senate race

Emily Roland:
Yeah, it's still very fluid here. We're looking at votes continuing to be counted, particularly, again, in those key swing states. One thing we do know here with certainty is that, similar to 2016, the polls were way off again, and the race is much tighter than expected. A little different from 2016, the equity markets were much more contained overnight, so we saw futures markets mostly positive overnight and certainly into the open this morning.

Emily Roland:
I think really the real news here is that the much‐hyped or anticipated blue wave has failed to materialize, so a Biden win with an all Democratic Congress. Again, nothing certain yet that the voting is not all counted. We could actually see, unfortunately, a contested part of the election play out here. We may see lawsuits start to pop up by either party as we continue to pursue these vote counts here, but it looks like right now the Democrats are very much likely to keep the House and the Republicans are likely to keep the Senate. This would, of course, result in a divided government scenario, really similar to what we've had in place before the election.

Emily Roland:
You know, we've all been a bit skeptical of the polls here. One thing that Matt and I have been watching closely is actually the market, and, in fact, the market has been a better predictor of the presidential election than the polls. And the stat goes that the S&P 500, if it ends the three‐month period leading up to the election positive, the incumbent party wins reelection. And that's been true every time since 1984 and 87% of the time back to 1928. So it was really down to the wire; in fact, a couple of days ago, it was just almost completely even going back three months; the market did end up Tuesday in positive territory. Again, this suggested to us that Republicans would win. Again, we don't know. It might not be the best indicator this time around, but something that we've been using to suggest that perhaps the race was again tighter than many of the pollsters had been predicting.

John Bryson:
Right. That certainly does seem relevant right now. Matt, Emily talked about the markets last night. We're a couple of hours into the trading day. What are they doing today to react to what's going on?

Matt Miskin:
Yeah, so, out of the gates, few markets are higher in terms of the stock market and even the bond market. In terms of the U.S. markets here, we're seeing a bit of a rotation back into higher‐quality‐type sectors. Healthcare is one of the best performers out of the gate. Think about less regulation, pricing, amidst a divided Congress. So if the Senate is remaining Republican, as Emily pointed out, and the House goes Democrat, it's going to be hard to pass legislation there. So healthcare stocks doing well. Tech communication services also up in the morning. We're looking at less risk of higher taxes on the corporate front, given that the Senate likely stays Republican. So I think the market's pricing in that a bit.

Matt Miskin:
And then on the downside, we are seeing some of the cyclical sectors, think energy materials, likely lower on less of a prospect of a substantial fiscal bill being passed. So that stimulus catalyst continues to fade here, and we believe that the markets are gravitating a bit more to those companies that can power through with strong earnings.

Matt Miskin:
And then quickly on the bond market. The 10‐year Treasury yield really whipsawed last night, so we went to as high as 92 basis points on a 10 year last night as the voting just started to be counted. This morning we're looking at 77 basis points, so that's a pretty large drop in Treasury yields, again, likely pricing in less prospects of a fiscal stimulus bill. To us, the intermediate part of the curve continues to look attractive here. Investment‐grade corporate bonds are rallying right out of the gate. That's a good spot, in our view, to be. So it's a balance of that quality side on the equity front, and then looking at good investment‐grade corporates on the fixed‐income side leading the markets the day after the election.

John Bryson:
Okay. So, Emily, when we talk about what's going on in the markets for the last couple of months, the possibility and the size of a stimulus package has really had a lot to do with what's happening. What are your thoughts going forward on the possibility of a stimulus package?

Emily Roland:
Yeah, I mean, I think Matt just really nailed that in the discussion around cross‐asset performance, leading up to this and how it's been impacted by investors pricing in this really large fiscal stimulus bill that we would have potentially gotten under a Democratic sweep. So with yields backing up, with cyclicals reflecting this reflation trade that investors were expecting on more fiscal stimulus, that's reversed a bit. If you think about Republicans being likely to keep the Senate, a substantial stimulus bill is less likely here. We could see something like maybe $500 billion; we've seen estimates up to maybe even $1.2 trillion, but this is different than the $2 to $3 trillion stimulus bill that had been expected under the Democratic sweep.

Emily Roland:
I think one thing that is maybe a bit under‐covered here is that even though the stimulus bill will be smaller, likely, there's actually more of a chance of it happening sooner if Trump wins his second term. So it’s something that could be done in between now and the inauguration in January if Trump actually does stay in office again, likely to be a smaller package, but I do think that if you look across the geopolitical strategists that we work with, most are expecting that we do get something in 2021 regardless, but again, a much smaller size.

Emily Roland:
I think the final point on that is the Cares Act is massive. $2.6 trillion that we got back in March, and that's still being put to work today, which is one of the reasons that the economy has improved as much as it has. So fiscal stimulus is still an action now and again likely to get more, which should be supportive of equity markets.

John Bryson:
So, Emily, play out a hypothetical for me. Let's say the Congress does end up being split. How would things be different under Trump versus Biden, if that were the case?

Emily Roland:
Yeah, that's a great question. So I think that we can start by thinking about Biden under a divided Congress first—and by the way, that's sort of where the betting odds are right now—but anything could change here. The first thing to note is that would actually be very rare. Getting a new president with a Senate from another party has actually only happened twice since World War II. So, normally, the presidential race dictates what happens down the ballot, and that may not happen this time. Again, it goes back to thinking about this blue wave scenario that many forecasters had predicted that would have resulted in things like higher taxes; I think certainly investors have been focused on that. Biden had proposed raising the corporate tax rate back up to 28% and imposing more taxes on individuals as well.

Emily Roland:
He also had an agenda that was filled with ideas around changes to the Affordable Care Act. Maybe even something like a potential public option, things like massive spending on infrastructure, green energy, things to combat climate change. A good chunk of that agenda will probably be dead on arrival now if the Senate does remain under Republican hands. There are things that a Biden president could do with the divided Congress under executive action. So things like pursue more regulations, lighten up on tariffs, which I think is possible, particularly as it relates to Europe, maybe not necessarily China. We think he's likely to keep a hard line on China, but the big issues, I think, that investors were primarily concerned about what will maybe go away here.

Emily Roland:
Quickly moving to a Trump presidency with a divided Congress. Again, it's more of the same. That's where we've been over the last couple of years. Then, similarly, he would be limited to pursuing agenda items that can be done via executive action. So maybe continuing with protectionist measures, deregulation, et cetera. There was a proposal under Trump to see some further tax relief. That probably won't happen, but again, more of the same and, frankly, investors tend to like gridlock. There are fewer unknowns and that may well be either scenario that we're in for heading forward.

John Bryson:
Thanks, Emily. So, Matt, back to you just to close this out and bring it back to the markets. With this uncertainty, how should investors be thinking about the rest of this year and heading into 2021? And have any of your views in Market Intelligence changed?

Matt Miskin:
Well, we believe that the core principles of a balanced portfolio still actually, if anything, are more warranted today and will shine through into the close of this year. So the fact that the Treasury yields are finding a bit of a ceiling around 90 basis points suggest bonds won't see too much negative price action. I think the equity market has been choppy here. Not knowing if this gets contested, we wouldn't be surprised if we did see some volatility. But in 2000, when there was 36 days where we didn't even know who won the election, the market was only down 5%. So really not anything substantial there. I think you’ve got to find the right businesses that have the fundamental support to get you well positioned in 2021.

Matt Miskin:
We do think that results in a quality bias in the U.S. over non‐U.S. bias. We do want to look at mid caps and industrials as well, as the economic engine continues to improve here, regardless of the political noise that's out there. And then, again, for fixed income, I think that there's been a lot of negative sentiment around it, but at the end of the day, it's still delivering. We're looking at 2 to 3% income potential using investment‐grade corporates, a little bit of high yield, some work‐back securities, but that part of the portfolio is still delivering, and we would look opportunistically at equities amidst volatility to set up for 2021, and hopefully that's a better year all around.

John Bryson: 
Amen to that. Well, listen, it's a historical time in our lives and a fluid involved with time in our lives. And we're going to need to keep people up to date with what's going on. So folks, if you don't follow them, follow Emily and Matt on Twitter, Emily @EmilyRRoland and Matt @Mathew_Miskin. And if you want to hear more, please subscribe to the Portfolio Intelligence podcast on iTunes, or visit our website for the latest updates, jhinvestments.com. Everybody have a great afternoon. We'll talk to you soon.

John Bryson:

Hello, everyone, and welcome to the Portfolio Intelligence podcast. I'm your host, John Bryson, head of investment consulting at John Hancock Investment Management. As always, the goal of this podcast is to help investment professionals deliver better outcomes for their clients and their practice. Topics we'll typically address include advisor business-building ideas, capital market updates, the latest trends in portfolio construction, and investment insight from our veteran portfolio managers across our global network. Today, we're going to focus on an important topic that's relevant to all investors—specifically this time of year—and that's taxes. I'm joined today by Will Creedon, director of ETF capital markets at John Hancock Investment Management. Will spent the majority of his career in trading and portfolio management responsibilities, focused on equities, derivatives, and FX strategies, for several hedge funds and asset management firms around the world. Will, welcome to the call today.

Will Creedon:
Thanks, John. Thanks so much for having me. Looking forward to it.

John Bryson:
So, Will, we've talked a lot in the past, you and I, about ETFs, and we hear a lot in the marketplace that they're more tax efficient than mutual funds. Can you tell us why they are?

Will Creedon:
Sure. As you mentioned, it's certainly more of a topic of conversation this time of year, as advisors prepare for the capital gains season, but essentially the ETF is differentiated from the mutual fund in the way that it processes its cash flows. The traditional mutual fund is one where the shareholder, with their subscriptions or redemptions, essentially provide cash directly to the mutual fund. And when the mutual fund takes in investor cash, the portfolio managers have to go out and buy the securities in cash, and perhaps most important for our conversation around taxes today, when investors want to redeem shares of their mutual fund, the portfolio manager needs to sell securities to raise cash in the fund and then send that cash out to the redeeming investor. So one of the illustrations we try to make for the efficiency of an ETF over a mutual fund, first and foremost, is that mutual funds process subscriptions and redemptions in cash.

Will Creedon:
When a fund is selling securities to raise cash, that essentially creates capital gain and tax consequences for every shareholder in the fund. Now, the way that the ETF is advantaged in this scenario is that when an investor goes to buy or sell shares of the ETF, they go to the stock exchange to make that transaction, hence exchange-traded fund, and the way that the ETF is benefiting from a tax perspective is that when an ETF wants to process a subscription, that process is basically disintermediated by a broker or, in ETF world, we call them authorized participants, where the fund puts it on the brokers on the exchange to deliver securities in kind to the ETF, rather than cash. And most importantly, on a redeem, the ETF, when an investor wants to redeem fund shares, they can sell their shares on the exchange and that broker redeems fund shares back to us, the ETF.

Will Creedon:
But the secret sauce is that the ETF is able to send shares of the securities in the fund out in an in-kind fashion. And so the portfolio manager of an ETF is not selling stocks to raise cash—which is a taxable event—they are simply sending stocks out of the fund in kind. And so the ETF subscription and redemption process, or creation redemption process, is one of in-kind security transfers, which are nontaxable events. So the way that we always try to simplify it for advisors is that traditional mutual funds process redemptions in cash, which is taxable; ETFs process redemptions in kind, which is nontaxable

John Bryson:
Got it. In cash versus in kind is the key concept we want people to understand. Now, understanding the impact of taxes on your investments is always important, but we don't normally talk about it year round. We talk about it in the fall, and we're in the middle of October right now. Why are we focused on it right now?

Will Creedon:
I'd say there's three reasons why we think investors should be focused on tax management really this year, more than any other year, really in recent memory. To your point, John, it's always a part of practice management for advisors in the September, October, November, December period, as we head into calendar year end. But one of the reasons we think it's so important this year is, again, three things. One, with the market being as volatile as it's been due to the coronavirus pandemic, it's presented volatility and presented actual tax-loss harvesting candidates, or opportunities, for advisors to look at, which perhaps they haven't seen within their practice in four, five, seven, ten years. So we think it's opportune at this point to try and take advantage where possible of the COVID-driven volatility to tax-loss harvest. That's the first idea.

Will Creedon:
Second idea as to why it's so important is, as you said, we're in mid-October where it's some 13, 14, 15 days away from the U.S. presidential election, and with that is going to bring massive uncertainty from an investor and advisor standpoint with respect to future tax policy. So, no one can tell you exactly what the future tax policies are going to be with either administration due to the results of the election. So our comments to advisors are control what you can control right now and manage taxes as efficiently as possible within your client portfolios right now, because you just don't know what tomorrow's going to bring with respect to tax policy from the White House. I think third, and probably the most ongoing for the foreseeable future at least, is the macro economic environment that we're in currently. And John, your team at John Hancock, I believe envisions this being for the foreseeable future.

Will Creedon:
Let's call it for the next year or so. But I think that is one of extremely low interest rates and extremely accommodative government and federal reserve policy where the search for yield and, really, the search for income, is going to be extremely difficult for advisors and their clients. And so the point we would make is that tax management, and this concept of tax alpha, is more important now than ever because clients are going to be clamoring for every basis point they can get, or every dollar they can get, with respect to performance alpha, tax alpha, income, and really a lower tax bill. So all those things we believe to be extremely important this year, perhaps more so than any other in recent memory.

John Bryson:
Yeah, it makes sense. As we're in this low rate environment, any alpha you can get, whether it's a tax advantage alpha or just wise investment approaches, you take what you can get. Now, if I'm an investment professional and I'm looking at my client portfolios, where should I start to look at where I can maybe generate some of this tax alpha or some tax savings for my clients? And how do I introduce this concept to my clients without them feeling like I'm churning the account and simply looking to make a trade?

Will Creedon:
Yeah, it's a question we get a lot from the advisor community. Again, a lot of these concepts may be more familiar to some advisors than others, but, again, with the bull market that we were in prior to the COVID period, and now the volatility that we've seen, but we're back toward highs, I think the areas that can often get lost in the shuffle are areas of the clients’ portfolio that maybe haven't recovered as well in this calendar year as, say, the U.S. large-cap equity markets, as benchmarked by the, say, S&P 500 Index. If I'm an advisor, and I'm trying to introduce tax alpha to my clients, I would recommend looking in pockets of their portfolio—areas such as small-cap equities, deep value equities, emerging-market equities, perhaps. All of these sub-asset classes really haven't seen the recovery to historical highs that we've seen in large-cap-growthier areas of the market.

Will Creedon:
So you can introduce those smaller, perhaps less allocated to asset classes, where you can bring to your clients the idea of harvesting a loss and presenting that as a tax alpha opportunity by lowering their potential tax bill for this year, and when you talk about the concept of churning, you can always introduce to them that realizing a tax loss today, isn't something that has to be used in its maximum form this year. It can be carried forward into future tax years through the concept of a tax-loss carry forward. So, again, some concepts that some advisors would do well by digging a little bit further into that they can combat perhaps that client or household fear of churning by introducing not only the tax-loss and tax alpha concepts, but perhaps the tax-loss carry forward concept that would make this more of a longer-term value add, rather than illustrating a risk of churning in the short term.

John Bryson:
So, let's say I'm on board. I'm a financial professional, and I appreciate the benefits that ETFs bring in terms of tax efficiency, but I've got some of my favorite mutual fund managers that I believe in, in the long term. How should I think about building these options into my process as an advisor?

Will Creedon:
I think one of the things we often say is that the ETF wrapper isn't a panacea to tax management, right? It's a useful tool, but as you said, most the clients that we deal with believe in broad diversification across managers and diversification across wrappers. They use mutual funds and ETFs. So when you're talking about tax management or tax-loss harvesting with respect to how I would implement it into my practice, we often talk to advisors and illustrate to them how you not only need to focus on the qualified money in your practice. 

John Bryson:
So Will, if I'm an investment professional and I've bought in and understand the tax benefits of using ETFs and how they can be more tax efficient than mutual funds, but I still have some of my favorite mutual funds, I believe in their process and strategy, and want to use them in a portfolio, how should I think about building both into my process?

Will Creedon:
I think that goes back to some of the earlier comments we made about this low interest-rate environment, perhaps this low expected return environment where every basis point counts, we still believe in an advisor’s ability to go out there and find quality managers that can help them realize alpha and outperform. So the way that we've been talking with our advisors about introducing ETFs, or using more ETFs in their practice, are along the lines of things like your active risk budget, or your active cost budget. If you're allocating to active managers in asset classes where you think there's more alpha to be had, let's say small-cap equities or international or emerging-market equities.

Will Creedon:
We think the ETF can be simply a tool that the advisor uses to manage taxes efficiently—especially at this time of year—but doesn't need to abandon a quality active manager for simply a passive product. We think knowing how to swap an ETF for a compelling mutual fund for a shorter period of time, to help manage taxes, is still something that the advisor can use in a systematic way within their practice, and, after understanding the wash sale rule, going back into that active manager a month or so into the future to still try to stick to their process of picking good managers and really trying to realize alpha for their clients over the longer term.

John Bryson:
If an advisor does want to work on a better outcome for their clients, what are some of the tools that they can look at to help them with this process?

Will Creedon:
A lot of the tools that we had been discussing with advisors, a lot of them use them broadly already, but we perhaps introduce the more tax management-focus aspects of them. But areas as simple as morningstar.com, most of the advisor community use Morningstar in some capacity, familiarizing yourself with the tax cost ratio concept and tools within morningstar.com is always a good place to start. See what kind of effect taxes have had on a particular manager historically, and try to understand how that will affect your expectation of that manager providing alpha into the future.

Will Creedon:
And the concept we just talked about of swapping an ETF or another mutual fund for a particular manager to save on taxes, there are tools out there from etf.com or etflogic.com, all free services that are non-subscription based, available to the public, where you can do fun compares, with respect to holdings comparisons, exposure and risk comparisons, where the advisor can enter some of their holdings and then evaluate some potential ETF swap ideas that will help best fit their asset allocation and their risk/return expectations as they go through this tax management process. And a shameless plug for you and your group, John, you guys always do great work from an investment consulting standpoint.

Will Creedon:
A lot of the asset managers that our advisors deal with, John Hancock Investment Management being one, but several others as well, will offer the advisor services around asset allocation consulting, investment consulting in general, where tax management and capital gain management can be introduced into that process. Those are specific tools that we've had some pretty substantial conversations with advisors over the last couple of weeks and months that are simply just starting points. We think the advisor, hopefully, will be able to dig in, realize some questions of their own, and folks like us in the John Hancock Investment Management ETF desk, or your group in investment consulting, are always there to help the advisory community.

John Bryson:
Will, thanks so much for sharing your insight. We appreciate how important it is to pay attention to the tax impact on investment outcomes, and the information you shared today would certainly help our audience. Folks, if you want to hear more, please subscribe to the Portfolio Intelligence podcast on iTunes, or visit our website at jhinvestments.com to read our viewpoints on macro trends, portfolio construction techniques, business-building ideas, and much more. Thanks for listening to our show.