Parametric on propagation versus after-tax CPM

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Raewyn Williams

New Parametric research shows a marked difference in return enhancements when comparing super funds using a specialist implementation manager versus a backoffice custodial solution to manage the tax impact of investing.

“More funds are turning to questions of ‘how,’ and ‘who’ can help them to fulfil their legal obligation to focus on after-tax returns,” according to Raewyn Williams, director of Parametric’s Research & After-Tax Solutions group and author of the Australian research.

She said: “Propagation and tax-managed Centralised Portfolio Management (tax-managed CPM) are two very different ways of addressing the hot topic of investment tax leakage on superannuation portfolios, and are increasingly becoming two short-listed choices for superannuation funds. Our concern is that there is so little practical information to help funds to make this important choice.”

Parametric’s study is the first in-depth comparison of the differences between a custodian solution known as ‘propagation’ (or Tax Parcel Optimisation) and tax-managed CPM.

“We used the real-life trading histories of 16 super fund equity portfolios to quantify the value add of Tax-Managed CPM and then compared the results to a propagation subset,” Williams said.

“The results show a significant basis points return increase each year from Tax Managed CPM versus propagation. Many fund decision-makers will be surprised at the size of this return difference.”

“Our research identifies portfolio characteristics that could increase the value the custodian provides through propagation. However, the structure of Tax-Managed CPM gives you innate propagation as well, something that is not yet widely appreciated. So any benefit that a fund would expect from using its custodian’s propagation service is also delivered naturally by a CPM portfolio.

Williams said there are legitimate reasons why funds might opt for a simple ‘light-touch’ solution like propagation and after-tax solutions are always a question of ‘best fit’ for a particular fund. However, she implored funds to closely examine their available options to help them to make well-informed decisions.

“Good custodians and good Tax-Managed CPM managers should be all too willing to help a fund measure and compare the benefits of their recommended approach using fund specific data and realistic assumptions. This decision is too important to make based on something generic or overly optimistic.”

Williams welcomed the overall progress funds are making to ensure their investment ideas were not squandered through inefficient implementation.

She said: “Inefficient implementation has real, even if not measured, costs to superannuation funds and members.

“Any steps a superannuation fund takes towards managing the tax consequences of its investment activities is a welcome step forward and away from the tax-naive traditions of the past.”

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