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Fiscal Cliff: Chance to Remove Uncertainty?


President Barack Obama has been re-elected. Is there portent for the mutual fund and exchange-traded fund industry?

Probably not, according to industry executives. But the first year of his second term, 2013, could be momentous, regardless, particularly with the so-called fiscal cliff arriving early on.

"I don't necessarily see the re-election, or should Mitt Romney have won office, changing any of the ETF business side," affirms David Mazza, head of ETF investment strategy at State Street Global Advisors. "The benefits of ETFs make them actionable for investors under Obama for a second term."

On the mutual fund side, good times could be back, if the $600 billion mix of tax increases and spending cuts that will avoid the so-called cliff are agreed upon, in pragmatic fashion.

"I anticipate that, following the political dialogue and compromise in the coming 100 days or about, 2013 would again be an extraordinary growth year for the mutual fund industry," said Avi Nachmany, executive vice president and director of research at Strategic Insight.

Some investors likely will wind up in higher tax brackets with higher taxes, according to Mazza, who recommends tax-free municipal bonds to help address some of those needs.

To generate income, real-estate investment trusts may get a boost as activity picks up in the housing sector. Investments in infrastructure and healthcare also stand to benefit from Obama's reelection, he said.

The value of retirement plans and tax-deferred annuities become much more important when taxes increase, noted Andrew Friedman, principal at the policy-analysis shop Washington Update, in a Sammons Financial Group discussion online in early November. Investors may also want to sell invested assets in the next month to lock in gains before taxes increase.

Nachmany expected that though the first quarter may remain "uncertain," the stock market should remain positive for most of 2013. "Clearly specific new tax policies would impact demand for tax-free bond funds, high-dividend stock funds, etc. - but these should unfold over time once such policies are in place," he said.

Other changes? Certain provisions of Dodd-Frank Wall Street Reform Act and the Affordable Care Act (ACA) legislation, while trimmed down, are here to stay, said former MFS Investments chairman Robert Pozen, in a separate online discussion. These include the Volcker Rule, which prohibits bank from proprietary trading and making speculative investments that do not necessarily benefit their clients, from Dodd-Frank. Meanwhile, popular parts of ACA have already been enacted, such as allowing children up to age 26 stay on their parents' medical insurance plans. Other parts of the act - including Medicare cuts and taxes and the Independent Payment Advisory Board, which is designed to help keep costs down in Medicare and is not yet in operation - may be vulnerable to change.

Demand for registered investment advisors is likely to continue, although the Securities and Exchange Commission "will likely take years ... to harmonize," fiduciary rules between RIAs and brokers, Pozen said.

The main concern? The $1.1 trillion a year U.S. budget deficit and the debt it incurs to carry it.

"The first priority of our elected officials now should be to get this country's fiscal affairs in order to manage our growing national debt," Investment Company Institute president and CEO Paul Schott Stevens emphasized.

That may be. But fund firms also fear that the tax increases and spending cuts enacted to avoid the cliff could drag the U.S. back into a recession.

In fact, the fiscal cliff has already begun "dragging" down economic activity, according to Dirk Hofschire, senior vice president of Fidelity Investments' asset allocation research team. Many businesses have already began tightening their belts, becoming more conservative with both their investing and hiring plans, in preparation for the country braking to avoid falling over the cliff, he said.

Investors and consumers could also get wary of their finances going forward, potentially creating more volatility in the markets, the executives contend.

"The fiscal cliff could have the potential to have people focus on the negative risks here and pick up volatility and a rockier path for stocks and other asset categories," Hofschire said. "It's a clear and present danger in the near-term for the U.S. market."

The problem is that reaching a grand bargain agreement will be difficult to say the least, if not nigh impossible, given the ongoing inability of Republican and Democratic lawmakers to compromise or work together.

In general, Republicans prefer spending cuts with no tax increases, while Democrats favor tax increases with minor cuts. And that dynamic hasn't changed with the recent election, these executives note.