Home / Behind the investor interest in after-tax management

It is no surprise to Anthony Serhan, who has been studying the differences between pre-tax and after-tax management and reporting in the industry dating back more than 15 years, that there is currently a surge in interest by investors across the board.

Serhan, a managing director and head of research strategy for Morningstar in Asia Pacific, said last week that the after-tax call is strongest after a bull market, such as in 2001 or 2007 and is getting stronger again, as most big funds have used up previous tax losses.

But it is not just big super funds who get interested in tax-effective management when they have to pay more tax. In 2007, he recalls, more effective after-tax performance discussions were becoming widespread throughout the retail (planners) and wholesale (platforms and dealer groups) markets because they had had four years of double-digit returns and leading to large fund distributions. “People start asking questions when just holding their $100,000 investment results in $30,000 of taxable income”.

Serhan wrote his first paper on the subject in about 2001, after “tech wreck”, when he was steering the research effort at the old ASSIRT.

He carried on the work at Morningstar, which he joined as head of research in 2003, and produced a study there in 2004 on Australian retail share funds, which analysed the income distributions and capital components, both of which are impacted by tax. Morningstar began publishing after-tax performance figures in Australia in 2006, which proved prescient.

Serhan says interest in the topic tends to wane when the unrealised gains from investments dissipate in the next bear market, and the financial crisis provided a hefty bear market.

“But putting cynicism to one side, every time the industry does make a push on tax things do get better,” he says. He believes the industry, including Morningstar, could improve its communications with investors on the topic.

And, he says: “A lot of the benefit is captured just by upgrading systems and processes, such as with specific tax lot identification, trust deeds that allow the allocation of capital gains to large redeeming investors and better treatment of buy-backs.”

He says: “On the wholesale/retail side we are still frustrated by managers’ inability to send relevant data on distributions. The few times I have done a lot of work on this, the interesting thing is that while after-tax returns can be improved, it rarely results in any significant change in the ranking of managers.”

However, the 2004 study showed that top-performing retail funds paid out far higher levels of realised capital gains but delivered only marginally higher levels of franked income than bottom-performing funds.

The study also showed a big range in net returns from funds which stated a particular “tax focus”, Morningstar concluding that many investors had not been getting what they were looking for. Some managers with no claim to a tax focus, actually produced better after-tax returns.

The fund manager which is best known for its after-tax management in Australia, including CPM, is Parametric Portfolio Associates, which participated in roundtables organised on behalf of PwC on the subject this month, as reported last week. Tax, according to both Parametric and PwC, is the biggest single “leakage” from performance for super funds.

“At the end of the day the whole industry benefits from making sure investors don’t pay tax any sooner than they have to,” Serhan says.