Sunsuper, the $69 billion industry fund, has changed the way it judges equity managers in a bid to stop them boosting gross returns through short-term trading.

Greg Barnes, head of listed shares at Sunsuper, said the fund has shifted its Australian equity managers from a pre-tax to an after-tax performance benchmark to better align their returns with member outcomes.

At the Investment Magazine’s Equities Summit, he conceded that the new regime is a significant headwind for investment managers, depending on their style. “It’s been a negotiation,” he added. “We needed to make sure managers are not being entirely disadvantaged since there is a reduction in their expected returns.”

Barnes said this was a hot topic prior to the global financial crisis when asset owners incurred significant tax losses. But having now recouped those losses, super funds are starting to pay tax again and the issue has re-surfaced.

“A major disconnect is that investment managers live in a pre-tax world,” he said. “So, their performance fees and returns are measured on a pre-tax basis whereas our members live in a post-tax world as they receive returns after paying tax.

“Even our stock pickers – our highly idiosyncratic managers – pay lip service to post- tax benchmarks. They will tell you it’s embedded in their valuation process, but peel back the layers and it is clear it is something of an afterthought.”

With close to half of Sunsuper’s Australian share portfolio allocated to passive management, Barnes initially didn’t see the benefit in measuring managers on an after-tax basis.  However, he changed his view last year after a spate of off-market share buybacks –  including by mining giants BHP and Rio Tinto – which were tax efficient for members.

While stocks were bought back by companies at a steep discount to market price, shareholders reaped big tax benefits through franking credits as well as a much lower sale price for capital gains tax purposes.

Moving to an after-tax performance measurement ensures investment managers don’t forfeit franking credits by refusing to hold shares for 45 days. Or they might miss capital gains exemptions by selling within a 12-months window. “These things can reduce the tax drag for members,” he said.

Barnes said some managers have now changed their approach to equities and consider how best to build that benchmark exposure.  “They can start flexing around that in terms of positioning themselves to rebuild exposure to those particular securities.”

Elizabeth Fry has been a financial journalist for more than 25 years and has written for a number of publications, including CFO, The Financial Times and The Australian Financial Review.
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