John Nolan, founder of JANA and former maverick asset consultant, said a few years ago that the lack of insistence on after-tax management among their preferred managers had been an indictment on his own earlier profession. To his credit, Nolan made up for it when he devoted himself to funds management at Warakirri Asset Management, introducing the first after-tax measurement system for multi-managers.
Since last year, after-tax management and reporting has taken on a new, if belated, urgency. All asset consultants insist on the reporting part and assess managers on an after-tax basis, although neither is a simple business. Both MySuper and the broader StrongerSuper laws of last year force trustees to consider after-tax implications of investment strategies and implementation.
Lots has been written now about after-tax investing. We have moved past the fact that it’s important to the nitty gritty of the best ways to implement the various aspects of management.
Parametric, the Seattle-based subsidiary of Eaton Vance, has produced a paper for Australian investors, “Essentials of Tax-Efficient Investing in Australia”, which presents both an overview of the current tax environment and analysis of theory and practice in after-tax management and measurement.
Scott Lawrence, managing director of Parametric Australia, says: “We estimate that an active manager for a typical superannuation fund would have to generate approximately 50-150bps of additional return per year to compensate for the drag from taxes. This is a difficult hurdle for many investment management processes.
“Minimising turnover is one possible solution, but a better method is to mitigate the effect of taxes by actively managing the realized capital gains and losses throughout the year. If done consistently through the year – while keeping careful track of tax lots – then tax management can generate as much as 30-90 additional basis points…”
There are six basic techniques for increasing a portfolio’s tax efficiency. The first three are more “passive” and the second three “active”. They are:
- choice of accounting method – HIFO (highest in, first out) is best
- yield consideration – franking credits can reduce tax
- corporate actions – actions such as share buy-backs can have significant impact
- capital gains management – investors can defer payment of the tax indefinitely, since it is paid on realization; if the sale is at a loss, it reduces the tax
- manage the holding period – super funds are taxed at 15 per cent unless the asset is held for more than 12 months, when it drops to 10 per cent
- pay attention to transitions – withdrawals, benchmark changes, manager changes or any time assets are sold.
The paper says: “Active tax management is more than just deferring the realization of capital gains and prudently realizing losses; it is about paying attention to the trade-off between risk, return and taxes whenever an investment decision is made and whenever assets go through a transition.”
Parametric and its affiliate, Parametric Risk Advisors, manage about US$90 billion of assets. Parametric has two main strategies:
- Engineered alpha strategies, which seek to outperform designated benchmarks on a risk-adjusted basis by applying systematic, rules-based approaches developed through research and experience.
- Engineered implementation services, which involve constructing and managing portfolios to meet market exposure, risk management, tax management and return objectives in a cost-effective manner.
Parametric Risk Advisors provides option-based strategies that alter the risk/return profile of existing investments, such as enhanced yield, greater total return, and/or lower volatility. Underlying investments can include concentrated individual stock holdings as well as more diversified passive or active equity portfolios.
The paper is available at: