If investment managers were incentivised to perform better on an after-tax basis, then there would be a fundamental shift in how they managed their funds, according to after-tax providers.
FTSE director Australia Julie Andrews said the first step for wealth managers and superannuation funds to provide better after-tax outcomes for investors was “to actually measure investment managers against an after-tax benchmark”.
“By reporting across all the different tax brackets this also allows investors to assess how much they may be being ‘penalised’ by having their investment in a pooled fund where a manager may not be acting in the best interests of whatever tax bracket they happen to sit in.”
Parametic managing director Australia Scott Lawrence said many wealth managers and superannuation funds represented investors with differing tax rates, but few could yet manage the underlying investment portfolios for all investors in a tax-effective way.
Andrews said that applying the correct benchmark depending on the customer’s tax category was essential to aligning the aims of the investment manager with the client.
A tax-exempt investor would not want to use the same benchmark as a superannuation fund which paid income tax of 15 per cent.
For example, the 12 month return (to July 31 2012) for a tax-exempt investor in the FTSE ASFA Australia 200 Index Series was +2.76 per cent compared to +1.75 per cent for a superannuation fund (taxed at 15 per cent).
“Likewise, fund managers who are managing funds for the highest personal marginal income tax rate payer will not want a benchmark that uses less than the 46.5 per cent income tax rate,” she said.
Investors should evaluate the source of returns, so reports should be “highly granular” with returns attributed to the different elements of price, dividends, franking credits and buybacks.
This allowed investors to see specifically where the manager added or lost value compared to the rest of the market.
Lawrence said fully franked dividends are more valuable to charities and retirees than to accumulation phase superannuation members, or private investors.
For example, the after-tax value (ATV) of $100 fully franked dividend would be worth $142.86 for a zero tax retiree. For a pre-retirement super member paying 15 per cent tax, the ATV would be worth $121.43, and for private clients paying 46.5 per cent, the after-tax value would be $76.43.
There were more tax benefits when investing in a diversified portfolio of Australian equities compared to international equities. But, these benefits must be balanced with the currency risk of international investing.
“In rising markets, the higher turnover of active management can result in higher capital gains tax costs compared to indexing. For taxable investors, this raises the hurdle for the success of active management. The higher the investors’ tax rate, the higher that performance hurdle becomes,” he said.
“To manage a large number of investment portfolios in a genuinely tax aware way requires managing separate investment portfolios for each (tax rate) investor category.
“Many firms use a pooled approach within their investment structures, which results in zero, 15 per cent and even 46.5 per cent tax rate investors having exposure to the same asset class portfolio. Such structures make tax-effective investment management for all investors impossible.
“For example, in many superannuation funds, the proportion of assets that relate to retirees is much smaller than those for accumulation phase members.
“As a result, the post-retirement assets may not yet be of a critical mass to enable effective management as a separate portfolio.”
