by Greg Bright
The proposed best-of-breed 10-manager panel to choose default funds plus forced amalgamation of funds which have underperformed for a period grabbed the headlines following the Productivity Commission’s final report on superannuation. For some practitioners this masks a missed opportunity.
In 2011, when Bill Shorten, as minister for Financial Services and Superannuation, enacted the Labor Government’s ‘Stronger Super’ changes, APRA introduced a list of specific items, deemed covenants, under the old SIS Act that trustees were duty bound to consider in the management of investments. One of these was to be conscious of the tax implications of their investment decisions.
In the two inquiries since then – the Murray Inquiry and now the Productivity Commission report – as well as the many statements from the regulator, there has been a paucity of comment from the authorities, let alone any action.
In a new report, ‘After-Tax Returns: Filling in the Productivity Commission’s Report’, produced by implementation specialist manager Parametric, the results of poor tax management are laid bare, not for the first time. Parametric has been championing the cause since 2012 in Australia and 1987 overseas. The firm is based in Seattle. As the latest report reiterates, up to 59bps is left on the table because of inefficiencies in tax management.
While Parametric and other like-minded managers such as Russell Investments have had some success in convincing super funds of the benefits of better tax management, the up-take has been nowhere as universal as one would ordinarily expect. If you put the loss to the Government Budget aside, it’s free money.
The absolutely best way to minimise the overall tax on an equity portfolio is through centralised portfolio management (CPM). This is where the CPM manager gathers all the transaction orders from the individual managers on a super fund’s list and transacts on their behalf. Parcels are arranged so that capital gains tax is reduced or eliminated and internal crossings, where possible, can avoid brokerage and similar charges.
Even custodians have the ability to provide a limited version of this service (without the investment management). In the early 2000s, NAB Asset Servicing, then the largest securities services firm in Australia, introduced a simple version of this service which it called ‘Master Manager’. But NAB, despite all its marketing resources and big client base finally gave up on the product.
The problem is that, notwithstanding the will of the super fund trustees and management, some underlying fund managers are opposed to CPM and place various obstacles in the path of the fund’s tax-efficiency goals. This is certainly what NAB found, even though it had more industry fund clients than half of the custodian universe put together.
Some fund managers, it seems, fear a loss of control over a piece of their investment process and/or want to protect their own, often staff-heavy, back offices. This is despite Russell research, also in the early 2000s, which showed a wide disparity in the efficiency of manager back and middle offices in buying and selling shares, even on a before-tax basis.
In fact, Russell had a product, which mimicked the trades of certain managers AFTER those managers had transacted. That is, Russell hoped to absorb the market impact of the managers’ transactions and, through better implementation, still come out in front. However, the trade-off between capturing the ‘alpha’ from managers’ best ideas and sitting on these ideas for up to two weeks to capture implementation efficiency (the Russell model) proved difficult to get right. Parametric’s CPM approach avoids lagging and gets the centralised trades to market as soon as possible after adjusting for its tax management overlay.
Raewyn Williams, Parametric’s managing director, research, and the latest study’s author – and also a former Russell head of after-tax investing – says the Productivity Commission did mention the importance of after-tax management, but the reference had no background or depth because of the lack of data. There was certainly no recommendation attached to it.
The Productivity Commission said on tax: “At a high level, super funds are taxed on investment earnings at 15 per cent. But in reality the actual rate paid is quite different as investment earnings in the pension phase are tax free, and the use of franking credits and capital gains tax discounts can greatly reduce the effective rate paid. While the environment is complex, how funds manage tax . . . is important because it can make considerable differences to the net returns credited to a member’s account.”
Williams says in her report: “Our aim is not to offer new material to the Commission. Rather, it is to reposition genuine after-tax investing in the minds of superannuation funds as a relatively untapped area of opportunity as they respond to the Commission’s findings and the Government’s recommendations in 2019.”
Commenting on her report separately, Williams said that having a focus on tax relief within a fund was an opportunity for all the relevant service providers to signal their alignment of interests with the client and, ultimately, the fund members.
“We believe that there is room for more managers to be thinking harder about this opportunity and getting their heads around the various ways a super fund can reduce the overall tax from its investments.”