Welcome to the May issue of Condor Monthly! In "What's New at Condor Capital," we introduce Rahul Shah. In "From the Portfolio Manager" this month, we examine PowerShares Global Water Portfolio. Finally in this month’s "Financial Planning Corner," we analyze the recently passed Tax Increase Prevention and Reconciliation Act of 2005 and how this law will affect our clients.
What's New at Condor Capital
Condor Capital is pleased to announce the hiring of Rahul Shah as a financial analyst. Rahul is a graduate of Rutgers Business School in New Brunswick, NJ with a degree in Finance. He worked in the Corporate Services department as an intern for over a year prior to graduation where he researched and analyzed the various mutual fund choices within 401(k) and deferred compensation plans for Fortune 1000 clients. Rahul is also a member of the investment committee, where he shares his research on current holdings and potential picks for inclusion into the company's portfolio. Please join me in welcoming him aboard fulltime!
From the Portfolio Manager
PowerShares Global Water Portfolio (PHO)
About the PowerShares Global Water Portfolio:
The PowerShares Global Water Portfolio, which is an exchange traded fund that trades under the ticker PHO, is a recent addition to clients' portfolios and seeks to track the Palisades Water Index. The Index includes companies drawn from the water utilities, treatment, analytical/monitoring, infrastructure/distribution, and water resource management areas of the market. The Index also holds some conglomerates, or companies that contribute significantly to the water industry, yet are extensively diversified amongst other industries or markets.
The Must-Have Commodity
You wouldn't typically think of water as a scarce commodity, with more than 70% of the earth's surface covered by it, but it costs money to make water potable and desalinization has yet to become economical on a large scale. The key attraction of water as an investment is that demand is accelerating and is not affected by inflation, recession, interest rates, or changing tastes. You can live without steel. You can live without oil. You can live without gold. But you cannot live without water. The problem is not that the world is running out of water, but that drinkable surface water is becoming increasingly polluted due to the urbanization of rural areas and industrial farming, particularly in the developing world and China. Water consumption in the 20th century has grown at twice the rate of population growth, and over the next 20 years, even the most conservative estimates expect hundreds of billions of dollars will be spent on global water infrastructure ($660B according to Hydrogen Ventures). There has also been a consolidation trend in the industry, as large conglomerates such as GE and Danaher have acquired some innovative filtration technology and have attempt to leverage their global scale to aggressively grow sales revenue.
Investing in Water
It's a little trickier to invest in water than in other commodity businesses such as energy or precious metals, as there really aren't any explorers, drillers, or pipeline operators. While we feel that the prospects for the industry are extremely bright, almost all US and European water is either managed by regulated utilities whose growth rates and expenses are capped by the government or are smaller in size. Instead, we found that the best way to play the coming water boom is through the diversified PowerShares Global Water Portfolio, which invests in companies that supply pollution-control, purification, pipeline construction, and irrigation control products as well as a couple water utilities.
Earnings Growth
Earnings for the inaugural version of the Index, which debuted in December 2005, are expected to grow 12% faster than the S&P 500.
Financial Planning Corner
The Tax Increase Prevention and Reconciliation Act of 2005
Earlier this month, the Senate narrowly approved a $70 billion tax cut package. On May 17, 2006, President Bush signed into law the Tax Increase Prevention and Reconciliation Act of 2005 ("TIPRA"). The Act extends provisions relating to capital gains and dividends, the alternative minimum tax, and small business expensing. The Act also contains several other provisions, including changes that impact the "kiddie tax" rules and Roth IRA conversions. Several provisions of the Act will have a significant effect on our clients and may require additional financial planning.
Key provisions of the Act are summarized below.
- Capital gains and dividends
The Jobs and Growth Tax Relief Reconciliation Act of 2003 reduced the maximum tax rate of long-term capital gains and dividend income to just 15% (for taxpayers in the lowest two tax brackets, the maximum tax rate is 5 percent and will drop to zero in 2008). These rates were scheduled to expire after 2008.
The Act extends the rates that will apply in 2008 for two years (through 2010). - Alternative minimum tax (AMT)
AMT exemption amounts, expanded under the Jobs and Growth Tax Relief Reconciliation Act of 2003 and the Working Families Tax Relief Act of 2004, expired at the end of 2005. For 2006 only, the Act increases AMT exemption amounts beyond their 2005 levels as follows:
- $62,550 for married individuals filing jointly
- $42,500 for single filers
- $31,275 for married individuals filing separately
- Roth IRA conversions
The Act eliminates the restriction that prevents individuals with modified adjusted gross income exceeding $100,000 from converting a traditional IRA to a Roth IRA. This change is not effective, however, until 2010.
In addition, the Act provides that individuals who convert a traditional IRA to a Roth IRA in 2010 will spread the resulting reportable income over the following two years (including the income ratably in 2011 and 2012). Individuals can elect to report 100 percent of the resulting income in 2010 if they wish. While there may not be much planning that can be done today, this could become a valuable planning tool in a few years. - Kiddie tax
Parents have traditionally opened custodial accounts (UGMA/UTMA) for their children in order to shift investment income (interest, dividends, and capital gains) to the child, who would be in a lower tax bracket. To avoid abuse, the tax code has contained a provision that taxes such income of children under the age of 14 at the parents' rate. This is commonly called the "kiddie tax."
The Act increases the relevant age of the kiddie tax from 14 to 18 effective January 1, 2006. Certain exceptions apply, but income in excess of the threshold amount, currently $1,700, for most children under the age of 18 will now be taxed at the parents' rate.
This change significantly reduces the tax advantages of large custodial accounts (UGMA/UTMA). Please call us if you would like to review whether this provision warrants a change in strategy for your children's accounts, such as shifting a portion of their accounts to an Education IRA or Section 529 College Savings Plan.
Other provisions worth noting:
- Section 179 expensing for small business
As a result of the Jobs and Growth Tax Relief Reconciliation Act of 2003 and the American Jobs Creation Act of 2004, small businesses can currently elect to deduct up to $100,000 of investments in depreciable assets in the year they are purchased. The deduction begins to phase out when a business's annual investment in Section 179 property exceeds $400,000. Both the $100,000 and $400,000 amounts are adjusted for inflation. Beginning in 2008, the Section 179 limit will return to its 2002 level of $25,000, and the phase-out limit will be dropped to $200,000. The Act extends the increased Section 179 limits through 2009. - The Act expands eligibility for qualified veterans' mortgage bond programs that allow states to finance affordable mortgages for veterans.
- The Act provides for capital gain treatment (rather than ordinary income treatment) for self-created musical works when these works are sold by the artist.
- The Act makes changes that impact the tax treatment of loans made to qualified continuing care facilities.
- The Act requires that individuals seeking an offer-in-compromise to settle their IRS tax debts make a good faith down payment with their application.
- The Act makes specific changes to the foreign earned income exclusion and housing allowance.
