U.S. fund industry weighs proposed Clinton tax increase

[July 21, 2015]  By David Randall and Ross Kerber

NEW YORK (Reuters) - Fund companies and brokerage firms should be able to weather a proposal by Democratic U.S. presidential candidate Hillary Clinton that would increase capital gains taxes for some investors, but some fund holders could see higher costs, managers and analysts said.

Though details of Clinton's plan have yet to be finalized, the candidate's proposal, first reported by the Wall Street Journal, would increase the holding period required to qualify for lower long-term rates. Currently, gains on investments held for less than a year are taxed at ordinary income tax rates, while those held for longer than a year are taxed at a maximum rate of 23.8 percent for the highest earners.

Brokerage firms that rely on customer trading as a revenue source might see a "modest" impact to their bottom lines should Clinton's proposal become law, said Richard Repetto, an analyst at Sandler O'Neill who covers the brokerage industry.

The plan may "slightly" reduce the number of trades by customers at brokerage firms such as Charles Schwab Corp, TD Ameritrade Holding Corp and E*Trade Financial Corp, he said. But about 75 percent of the daily volume comes from active traders who are already subject to higher taxes because of their frequent trading, and therefore would be unaffected by the higher rates, he noted.

Portfolio managers would have a harder job trying to avoid triggering capital gains taxes that would be passed on to investors, fund analysts said.

The average large-cap blend fund has an annual turnover of 70 percent, likely incurring a mix of short-term and long-term capital gains taxes for its shareholders each year, according to Lipper data. Most actively managed funds also tend to charge a redemption fee on shares held for less than a year in order to limit short-term trading by their customers.

The change would mean Clinton's plan could hit fund investors with more frequent capital gains taxes, said Todd Rosenbluth, director of mutual fund research at S&P CapitalIQ. Actively managed funds spread their own capital gains across all investors in the fund.

"This will impact mutual fund investors even if they have a long-term investment horizon because capital gains will now have to hit a different threshold. You could find yourself paying taxes at a higher rate even if you didn't do anything during that year," Rosenbluth said.

However, Brad Friedlander, managing partner of Angel Oak Capital Advisors in Atlanta, said higher rates would likely have a minimal impact on firms such as T. Rowe Price Group Inc and BlackRock Inc because most portfolio managers and shareholders tend to hold their stakes for several years.

Financial planners may see a windfall from any changes that complicate the tax structure, said Phil Orlando, a portfolio manager with Federated Investors in New York.

"It becomes a cat-and-mouse game as individuals sit down and try to figure out which vehicles they have at their disposal that are not subject to taxes," such as IRA accounts or 529 college savings accounts, he said.

(Reporting by David Randall and Ross Kerber; Editing by Richard Chang)

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