By Dan Pembleton
An investment has gone bad, maybe really bad—a 30%, 50% loss or worse. It has happened to almost everyone at some point, either personally or professionally, but recent markets seem to have made it happen a little too often. Of course as a dealing representative that makes you the messenger, and no one wants to go to a client just to inform them of their loss.
“Hi Fred, remember that investment you thought was going to pay you 10% for the next 5 years and then you get all your money back? So… That isn’t the way it is going to work out.”
Nobody wants a conversation like that on either side. As that messenger you need to have a solution. So what can you do?
1. Breathe. And then remember that a capital loss is a not an unusual situation.
You’re not the only one this has happened too. Remember Nasdaq in 2000? How about WorldCom, Sino-Forrest, Lehman Brothers, GM and the whole world in 2008/9? Not only are capital losses not unusual, they’re also not unique to any particular market, sector or form of purchase. They are a part of investing and the whole system of capitalism. Everything cannot work all the time. Bonds can lose money, public stocks can lose money, and real estate of all types can lose money as can private equity.
No one and nothing is immune— and yes, your client is also aware of this however the speech on “losses are a part of life” is not going to play particularly well with them in the moment. A better idea is to make sure you have a plan for when loss happens, not if. That way you’re not breaking bad news when it hits, you’re simply reminding them that you are prepared no matter what—and that will go far to maintain trust.
2. See if the minus can be made into a plus with loss carryback (Form T1A).
Let’s say a client finds themselves with a large capital loss. Maybe it’s 50% of an investment. What can you do for them now? Well, net capital losses are fully deductible against capital gains and may be carried back three years and forward indefinitely. So first things first, if a client has capital gains in any of the years prior to their loss it is time to get busy and fill out Form T1A, Request for Loss Carryback. You can choose which years the loss should be applied to— start with the year furthest and move forward from there until it is used up. This might not yield huge results but it will take the edge off that particular feeling of ‘investment loss futility’.
3. Make the effort to understand and be sensitive to your clients’ unique situations.
Research and assessment go a long way. There’s no reason why you can’t salvage trust and strengthen your client relationship even if a strategy isn’t going to work. Let’s go back to our fictional investment loss.
The T1A approach might not be an option in every case— if the loss was too large or if no capital gains were available for use in the prior three years, this means you can only look forward. Depending on your client’s situation (and if their losses were huge) it’s possible that it may take many, many years for remaining investments to generate gains to even use that capital loss. As an example, let’s take a loss of 50% on our investment—even if we had an 8% compound rate of growth on the remaining capital it would take 9 years for us to get back enough to even use the capital loss. Nine years is a long time to wait for recovery! Many clients can’t or won’t accept that kind of plan but at least you are aware.
4. Explore the use of tools like FTLPs to accelerate wealth recovery.
If a client is primarily invested in income-producing investments (simply not producing capital gains and with very little prospect of doing so in the future) then what? You could have a stranded capital loss which would be a complete waste, or Flow-Through Limited Partnerships (FTLPs) may be an answer.
In the exempt market, FTLPs can help accelerate the recovery of capital losses generated from other investments in a way that no other investment does. That’s because Flow-Through shares and the funds that invest in them—FTLPs— provide an immediate, roughly 100%, tax deduction to the investor. Go ahead and read it again.
The Canada Revenue Agency then requires that the Adjusted Cost Base (ACB) of these investments be reduced to zero—the result is a guaranteed capital gain!
This isn’t the only reason FTLPs can be a go-to tool for helping clients with losses.
FTLPs also offer a lot of flexibility for clients in making deductions against all types of income, so if a client is earning income, paying tax and has a capital loss, they are a candidate for using this planning technique.
5. Actively motivate clients to visualize recovery with planning techniques.
Clients will feel better when they see that even after loss they still have options. As a DR, you can help by keeping explanations simple and clear—distil concepts as much as possible for clarity. For example, the FTLP approach for a client with capital losses can be broken down into 3 simple steps:
1. A client can reduce their immediate tax bill by making an FTLP investment and then deducting it against income in the first year.
2. When the FTLP capital is returned to them upon liquidation of the fund, it triggers a capital gain.
3. The client can then use their capital losses to offset the capital gain.
Immediately the client can see past their tax bill to the writing off of capital gains. Add in that they can now effectively use their capital losses against income and they will feel fully empowered to plan with FTLP features and help speed the recovery of their wealth.
6. Use results to drive trust in the wake of loss— not sales.
As a DR there is a time to be excited about new tools and products, and periods of loss are not that time. Stick to the numbers, comparisons and visuals. Clients dealing with substantial loss do not need a quick fix – but they will appreciate being given a hand to shift their loss onto the Government’s back through reduced income taxes. Showing them how is the way lifelong investor relationships are made.
Below is a simple comparison of FTLP returns when there is no available capital loss and when there is. It assumes a 45% marginal income tax rate and FTLPs have no change in value from the initial investment.
For every $10,000 of investment made in FTLP, $5,500.00 can be saved in income taxes when there are capital losses available. In my opinion FTLPs are great tax-planning instruments even when capital losses are not available, and when they are it is twice as good- but it’s not my opinion that matters. It’s the numbers, the results and the flexibility of FTLPs.
Of course FTLPs are also an investment and the results are subject to variability. As a DR, look at your client’s situation through that lens, as well as what time horizon they need to reclaim their capital losses. A healthy, risk-sensitive strategy we encourage is for investors to spread their investment in FTLPs through time.
7. Choose innovative products with client-facing missions.
You know that phrase necessity is the mother of invention? In our world, loss is the mother of better investment tools. When I saw how market cycles impacted investment losses in my circle of friends and family, I decided to create a better product. I loved the concept behind FTLPs but I wanted my clients to have something even better.
When we started developing our first FTLP fund back in 2007 we didn’t know what the future held or how our new tool would perform, but we had a strong mission. We built in a flexible three-year timeframe that has helped to weather brutal market conditions again and again. We assembled a team of advisors with their fingers on the pulse of their respective resource sectors. We actively worked with market conditions and select the proper timing for share liquidation—unlike other FTLPs we didn’t roll anything into mutual funds. We put our investor needs first because far from wanting our investors to experience loss, we want to help them avoid claw-backs, shelter their income, and save on taxes.
In closing, loss is simply part of the up and down cycle. We can’t avoid it but we can all be prepared for it. We can apply loss carry-back, and we can keep clients motivated to recover with tools that are going to give them the best results. We can all continue to develop products and approaches that minimize risk and help soften whatever the markets might throw our way. Because even during the most volatile market, both investors and DRs can experience trust building, dependable communications and understanding, and keeping positivity in all their actions and advisements— and that is an investment we all know pays off.
Dan Pembleton CFA, MBA founded Accilent Capital Management Inc. in 2002 to provide investment advisory services for third party and proprietary funds, individual managed accounts, and structured investments. He has been working in the financial industry as a trader and portfolio manager for 15 years. Nearly a decade of this time was spent with RBC Dominion Securities in institutional fixed income where he rose to the level of Vice-President Global Money Markets. Mr. Pembleton is the Commodity Trading Manager (CTM) and Commodity Trading Advisor (CTA) in addition to being Portfolio Manager for Accilent. Mr. Pembleton’s education includes an Honours BA in Economics and Business from Brock University, an MBA from Western’s Ivey School of Business and a Chartered Financial Analyst (CFA) designation in 1998 from the CFA Institute.