// CASE STUDY

M3’s Process At Work
The value of M3’s Three Phase Tax Transition is best illustrated by looking at an example. 

The client, who was introduced by a multi-family office, was a retired physician. Having accumulated significant equity positions over the last 20 years, he was now focused on generating income and protecting his principal, but he still wanted to grow his assets through some market exposure.

His $16.5 million portfolio had $7.4 million of embedded gains. He owned no fixed income, small cap, international or alternatives, and 42% of the portfolio was concentrated in pharmaceuticals(3). Exacerbating his situation, the client had developed relationships with four advisors and as a result was confounded quarterly by over 280 pages of statements.

The client’s goals were clear:

• Generate more stable income flow
• Lower risk
• Diversify
• Simplify reporting by consolidating to one advisor
• Minimize realized capital gains in transition

The need to generate cash in order to buy fixed income presented an additional challenge. In order to achieve his goals, M3 and the advisor needed to develop an asset allocation model and transition strategy that would generate roughly $7 million in cash while creating a diversified portfolio. This had to be achieved while working within the client’s established realized capital gains budget – his tax tolerance – for the initial transition of no more than $500,000 in taxes or no more than $2 million in realized capital gains, based on the federal capital gains rate of 15% and his state tax rate of 9%. 

Having assessed and created a consolidated view of the client’s assets, M3 worked with the advisor to develop a proposed target portfolio and select managers willing to provide their models. The proposed allocation included four managers:

 Once approved, M3 began the process of transitioning the existing portfolio to a hybrid portfolio that would increasingly perform like the target portfolio. How closely the hybrid portfolio exactly matched the target is measured by Tracking Error. Tracking Error has an inverse correlation to realized capital gains, so the lower the tracking error the greater the tax bill.

During the initial transition, M3 had successfully moved roughly $7 million into fixed income, improved tracking error while staying within the capital gains budget: