(Pictured: Patrick Liddy)
There are easy dollars to be made where funds can increase returns without increasing risk, in the areas of tax management, cash and FX. “These are the only free kicks left in the market,” according to Patrick Liddy, principle of consultant MSI Group.
Liddy told the ASI conference that a fund’s custodian was its “greatest unused resource” and urged super funds to be proactive in their dealings with their custodians to improve efficiencies.
The two main areas, he said, were having a ‘master manager’ to oversee capital gains tax at the fund level and ‘tax parcel optimisation’ where it is ensured that the optimum parcel of shares is traded for tax purposes. Both of these take advantage of the duplication of big parts of manager portfolios to reduce not just tax but also brokerage and other frictional costs.
In a case study, Liddy said, it was found that a $750 million Australian equities portfolio had 87 per cent duplication of stock names among its managers. When both techniques were applied to the portfolio, the saving totalled 58bps.
“The master manager creates your own little dark pool for the fund,” Liddy said. “It can save 60bps across the entire fund. Tax parcel optimization [taken separately] can save 50bps.” The two processes overlap so the total saving is not necessarily 110bps.
He said custodians could do a lot more to assist, but needed to be prompted, and given the authority to do so. He thought that some were still struggling to decide on how to price the service, which requires extra work on their part. He said that for some portfolios and a better outcome, a fund should also use a specialist, such as Parametric.
Systems company DST introduced a tax optimisation module, which it called propagation, some years ago and its client NAB Asset Servicing promoted the service vigorously to super funds. However, Liddy and his fellow panelist at the conference, after-tax expert Raewyn Williams of Parametric, said the GFC slowed momentum of the pick-up by funds.
Williams, who has specialized in all aspects of after-tax reporting and management, joined Parametric from Russell Investments earlier this year. She said that what was missing from performance reporting was “tax alpha” and attribution reports so funds and managers could understand all of the tax pieces.
She also presented a case study, whereby the fund wanted to have a better way to calculate manager performance fees, with better alignment with fund members. Parametric created customized after-tax benchmarks and provided monthly reporting on each manager. The reports were given to the managers as well as the fund. The results were, since inception in July 2011, large-cap equities mandates had a tax alpha of minus 1.25 per cent and mid-small-cap mandates a tax alpha of minus 2.20 per cent.
Even though the fund did not set out to reduce the managers’ total fee, it now had a more appropriate basis to calculate performance fees, Williams said.
“It also enabled the fund to comply with the new SIS Act to calculate fees after tax,” she said. “There was a large reduction in performance fees paid but this wasn’t the prime objective. It also generated good engagement with managers.”
Williams said that managers could not best manage all taxes. For instance, capital gains tax minimisation did not work well in silos. A separate manager was best to co-ordinate the CGT. She produced a research paper earlier this year which argued that managers should be tasked with particular taxes to address.
