At Badgley Phelps, we believe active investment management, and the use of individual stocks and bonds, allow us to add value for our clients. Often, discussions on the benefits of active management focus on performance relative to benchmarks. However, we feel that is a narrow focus which ignores much of the flexibility and transparency that is provided by our approach. Here are five benefits of an active strategy that are often overlooked.

What is active investment management?

Active investment management is an approach whereby an investment manager closely monitors prices of individual securities and engages in ongoing buying and selling transactions with the intent of maximizing returns and minimizing risk. At Badgley Phelps, active investing means development of customized portfolios designed to meet our client’s financial goals, and honoring their values, while helping them manage their tax burden and the risks across all their assets.   

Benefit 1: Invest with ideals in mind

Some people prefer not to invest in companies in certain industries, such as energy and tobacco. Our use of individual securities and an active approach allows us to avoid investing in things that conflict with our client’s ideals. It also allows us to focus on companies with characteristics such as strong management teams and best in class governance practices.

Benefit 2: Better manage concentrated stock positions

Active investment management allows advisers to construct portfolios containing all the client’s assets, which may include managing concentrated stock positions. For individuals with a large position in a single stock, we can work to build a portfolio that provides diversification without the need to eliminate the concentrated stock. For example, if a client owns a significant position in a biotechnology stock, we can avoid or limit the number of stocks that we include from that industry. This approach allows us to introduce new investment opportunities without adding to the industry-specific risk generated by the concentrated position.

Benefit 3: Take control of your tax situation

Active management, and our emphasis on individual stocks and bonds, also enables us to create customized tax-loss selling programs based on each client’s needs. Unlike assets that are pooled in a single fund, individual securities each have their own cost basis which enables us to develop customized tax loss strategies for our clients.

Furthermore, the amount of taxable gains generated in each portfolio can be directed by the client.  Unlike the individual stocks in our portfolios, mutual funds and some ETFs make year-end distributions which generate taxable capital gains. Notably, the size of these distributions is often not known until the latter stages of the year and that can make tax planning difficult. We have the ability to manage to a specified level of gains, so we can avoid these surprises. Our approach also provides the flexibility to tailor the realization of gains based on specific situations. For example, if a client sells a piece of real estate and has a sizeable capital gain, we can work to limit the gains in the portfolio and may engage in more aggressive tax-loss selling to contain the overall tax bill. In addition, as active managers, we can optimize holdings across different types of accounts so that assets are in the most efficient location. With the goal of minimizing taxes, we can utilize tax-inefficient investments, such as those that generate large, taxable dividends, in IRAs and other tax-advantaged accounts. Conversely, we can also utilize more tax-efficient investments, such as municipal securities and stocks with long-expected holding periods, in taxable accounts.

Benefit 4: Intelligently approach charitable gifts

Gifts of appreciated stock are an excellent way for clients to donate to their favorite charities. Using this approach, they can make these donations while avoiding payment of the capital gains tax on the stock gifted. If desired, they can also increase the value of the gift by the amount of tax they would have paid if the position had been sold.

Benefit 5: Reduce the interest rate risk in your bond portfolio

Active investing can help clients get more out of their bond portfolios. At our firm, bond portfolios are constructed using individual securities rather than mutual funds or ETFs. This means that we can manage interest rate risk more aggressively than pooled vehicles. Put simply, as interest rates rise both individual bonds and bond funds decline in value. However, as a bond moves closer to maturity the interest rate risk declines since it will eventually mature at its face value, regardless of the interest rate movements. In contrast, bond funds and ETFs don’t mature. They maintain a relatively constant average maturity which means they have a relatively constant level of interest rate risk.

At Badgley Phelps, we believe every client deserves customized, transparent and understandable investment management. We feel the use of individual securities, and an active approach, help provide a higher level of customization and transparency. Clients know what securities they own, and we can help them manage risk around concentrated positions, control tax liabilities and maximize the benefit of charitable gifts. If you need help managing your assets, please contact us.