Warakirri now provides its after-tax measurement and reporting service (that includes benchmarking) as a standalone offering to super funds. It currently has three funds using the service, including HESTA. Rob Fowler, executive manager, investments and governance, for HESTA, says: “Given the weighting to Australian equities for most super funds, there are clear benefits for our members that can be achieved through our fund managers focusing on delivering after-tax, rather than pre-tax, returns. We are observing changed practices at many of our fund managers and our experience to date has validated our expectations.” For Warakirri’s multi-manager clients, they have piece of mind that the managers are being measured with their best interests in mind. The one and three year numbers across Warakirri’s four multimanager funds indicate value added on both a before and after-tax basis. The average net three-year before and after-tax alpha of the Warakirri multi-manager funds has been 2.9% and 3.8% respectively.
Perhaps the simplest way to look at the difference between before-tax returns and after-tax returns is to consider performance for tax-exempt investors. For taxexempt investors the difference is simply franking credits. The table below illustrates that franking credits can significantly add to the return of an Australian equities portfolio. For the past year, franking credits have added 1.8 per cent to the return of the portfolio and 1.4 per cent to the return of the benchmark. To be fair on the managers who have provided the better outcomes because of the new focus, they were largely unaware of the extent of the potential valueadd previously. Andrew Nolan quotes one manager who said that they had always valued franking credits, for instance, but now they have increased their assumed worth from 60 per cent to 85 per cent, and this could go to 90 per cent. Another said that focusing on the franking credits, at 100c in the dollar, changes the manager’s expected return stock rankings.
Franking credits on the balance sheet are valued at 75c in the dollar. So the difference puts pressure on companies to pay out excess franking credits. In a takeover of an Australian company by an offshore one, the franking credits issue can be very important. For example, Healthscope, which had significant franking credits on its balance sheet when subject to a foreign takeover, attracted some lobbying from institutional shareholders for part of the consideration of the bid to be paid out as a fully franked dividend – as franking credits are not valuable to overseas shareholders. For big super funds, the aftertax story can go a step further through the use of propagation programs at the custodian level. Andrew Nolan points out that this is a related, but separate issue, as it involves making sure the optimum after-tax position is accounted for at the whole fund level after the manager decisions have been taken.