Active Australian equities managers with high turnover and tax inefficiencies generate a tax drag that can match the fee they charge, according to the results of a new study conducted by Towers Watson.
The study - After-tax investing in Australian shares - found tax-inefficient strategies can cost between 0.14 and 0.4 per cent per annum for a superannuation fund investor depending on the level of portfolio turnover over five years.
Another conclusion of the study is that the impact of investing with a manager with higher turnover is twice as high for individual investors on the highest marginal tax rate than for superannuation fund investors.
Despite this finding, Towers Watson concluded tax efficiency is not the most important quality to seek in an investment manager.
"If you are confronted with a choice between a very high quality manager that is tax-inefficient and a mediocre manager that is tax-efficient, you are always better off with the first," Towers Watson investment services director Graeme Miller said.
He said selecting a manager capable of generating high pre-tax outcomes should be a priority.
Although active managers do face fee and tax challenges, the study, which was conducted in 2010, concluded these hurdles can be overcome by picking the right investment managers. "The overall conclusion was that despite these hurdles, they are not insurmountable for high quality investment managers." Miller said.
Miller said with small changes most active managers can improve net of tax outcomes through reducing stock turnover, greater harvesting of franking credits and participating in off-market share buybacks.
"Given two otherwise identical managers, we will always recommend the more tax-effective one before the tax-inefficient one because it means more of the gross returns for our members," Miller said.
