It’s often said that investment returns after-tax and fees are what super fund members ‘eat’. Too often, however, this truth isn’t reflected in the way funds invest. Big funds with billions invested in Australian equities should harness the tax benefits of franking credits, off-market share buy-backs and parcelling of shares to avoid triggering excessive capital gains tax (CGT). When combined with good stock selection, these measures can add millions to returns. Andrew Nolan, head of investor solutions at Warakirri, has joined his father John, managing director of the firm, in the multi-manager’s long-running support of a shift to tax-aware investing. “As an industry, we focus on pre-tax returns in performance surveys. At the end of the day, it’s the members who are important and they receive post-tax returns,” Nolan says.
There is a misalignment of interests between members, who receive after-tax returns, and funds managers who are rewarded for pre-tax performance. In his official review of the super system, Jeremy Cooper also identified the gains that can be made by prudent tax management and recommended that the law guiding trustees, the Superannuation Industry Supervision Act, be amended to make after-tax investment strategies part of fiduciary duty. But in an encouraging sign, some big funds have already taken action. They include the $17 billion Sunsuper, the $16 billion HESTA and the $37 billion AustralianSuper. Peter Curtis, senior manager of investments at Australia’s largest industry fund, says there are three actions that collective investment vehicles can take to minimise tax drag. They are: force individual managers to compete against an after-tax benchmark, prevent any unnecessary tax losses at the fund’s total portfolio level, and structure overseas investments so they preserve tax benefits.
AustralianSuper has so far acted to preserve tax benefits at the fund level. Since 2006, it has participated in off-market share buy-backs after taking this responsibility away from domestic equities managers. In the year before the financial crisis, this strategy alone added 50 basis points to the fund’s Australian equities returns, Curtis says. It has also implemented tax propagation through its custodian, JP Morgan Worldwide Securities Services. Because shares sold within 12 months of ownership incur a higher CGT rate of 15 per cent, and shares sold after one year of ownership incur CGT of 10 per cent, this strategy restricts the selling of shares purchased within this timeframe. In the 2006-2007 financial year, this it deferred 15 per cent of the $80 million in CGT payable on the fund’s Australian equities portfolio, resulting in a saving of $12 million, Curtis says. Since it applies to investment gains only, propagation is most effective in rising markets. But AustralianSuper has not yet prescribed after-tax considerations in the mandates it holds with investment managers.