“After-tax doesn’t mean you change your style of trading – I think that’s where some of the people in the industry get scared and think they have to become an index manager. That’s not the case. All you’re really being asked to do is add one extra thing that you look at when making investment decisions”.
ITG charges a flat fee for the benchmark, which Friend says is cost effective. He also says the benefits far outweigh the costs of implementing the after-tax environment. ITG also runs software that can aid a manager in determining the best trading decisions for after-tax performance.
Castro calls it “tax lot optimisation”. It helps the manager select which tax lots should be sold at a given time in order to optimise returns. Instead of the manager simply choosing a methodology that hinges on selling the oldest tax parcel first (to avoid capital gains, for example), the software facilitates deeper analysis. Castro says more information would be required from the manager for such analysis, and in this case, ITG acts more like a custodian than a benchmarker.
The Investment and Financial Services Association recently released a guideline for its members to report their after-tax returns. However, Robin Bowerman, Vanguard retail principal, says this move is focused on the retail market insofar as it will allow financial advisers and consumers to be more aware of what the tax implications of different managers are in light of their personal income tax rates. The reporting guideline should not be confused with a push towards managers investing with the aim of reducing the tax bill.
“The tax bill is probably one of the largest the superannuation funds will have to pay,” Bowerman says, so it makes sense for managers with a super fund mandate to be conscious of that. Castro believes eventually it will catch on to all managers when the reporting kicks in, investors start noticing, and managers across the board – retail or institutional – realise the cost effectiveness.
“We do the same thing with transaction cost analysis: if you can minimise your costs by minimising transaction costs, then that’s money for jam. If you just lost three basis points because you didn’t look at how your systems were doing, then that’s very hard to justify.
“And that’s what it’s all about – how much money can you come back to the investor with? My question to those who say [being tax-aware] is going to cost too much: do you actually know how much it’s costing you?”