Weigh up after-tax alpha to prevent leakage


By Sarah Kendell

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After-tax alpha considerations such as capital gains tax deferrals and discounts, loss realisation and withholding tax management should be as important to fund managers as pre-tax alpha harvesting techniques to generate returns for members, according to Parametric.

Speaking to financialobserver, Parametric director of research and after-tax solutions Raewyn Williams said it was important the superannuation industry consider both issues equally to build member investment portfolios.

“Alpha is a golden concept in the industry that people build portfolios around – it’s very legitimate because you can mathematically derive it and understand all the strategies managers use to generate it, so it makes sense intellectually,” Williams said.

“The question is why is after-tax alpha any different?

“If your starting point is that super funds live in a taxed world, after-tax alpha is just as legitimate.”

Williams said that as the Australian Taxation Office was a stakeholder in nearly every move funds made, from trading stocks to rebalancing an index, it made sense for managers within those funds to ensure tax leakage did not dilute their best investment ideas.

“Investing in the real world is full of noises and frictions, so one of the things we challenge funds with is that they can keep coming up with their best investment ideas and implementing them in a world full of frictions,” she said.

“So what they get in a real life portfolio is something less, or they could be a bit cleverer and modify the way they implement to give the minimum leakage of those frictions.”

Parametric research showed the average super fund could generate an extra 0.57 per cent return annually by taking tax issues into consideration when implementing their investment strategy.

“We created a base case with a typical amount of stock turnover, market returns and volatility, and assumed we had a tax manager whose brief was to create after tax returns, and our simulations showed that the average fund will get 57 basis points on top of its regular returns,” Williams said.

“We also tried to unpick that base case and say ‘what if market returns are different? what if turnover or cash flows are different?’, and we found that you don’t get too much difference in your tax alpha expectations regardless.”

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