Parametric Portfolio Associates has produced a new white paper – ‘Where Passive Falls Short’ – as a precursor to the firm’s launch of a range of tax-efficient smart beta strategies in Australia. A momentum-tilted tax-managed portfolio would have outperformed the ASX 200 after-tax by 56 basis points a year for 10 years.
The paper, written by well-known Australian after-tax expert Raewyn Williams, Parametric’s global CIO Paul Bouchey and research analyst Tianchuan Li, shows that the low turnover associated with traditional passive strategies does not necessarily mean the best after-tax outcome. In the study example, the ASX 200 passively managed would have a turnover of 6 per cent. The momentum-tilted enhanced-index strategy, generally known as ‘smart beta’, would have had a turnover of 20-30 per cent, which is similar to some active value managers, but still delivered the 56bps excess return.
The paper’s authors identified 10 areas where passive investing seemed to “fall short”. They were broadly grouped into:
> lost opportunities to add value on an after-tax basis which are ignored by passive managers
> ‘visibility’ issues which block the investor’s ability to measure the portfolio’s performance, and
> value in after-tax terms.
They said: “There is increasing interest in making ‘dumb beta’ smart through the intelligent use of factor tilts [such as momentum]. We urge superannuation funds to make it truly smart by seeking to deliver what really matters to members – better after-tax returns.”
Williams, director of research and after-tax solutions, said that the momentum style, which is often combined with value to avoid sustained underperformance in rising markets, had attractive pre-tax risk and return attributes and was “naturally tax-efficient”. But the benefits of low turnover through passive investing represented an over-simplification and were often misleading. “Passive managers often don’t have tax-management capabilities,” she said.