The after-tax benchmarking of Australian equities is suddenly the latest ‘hot thing’ due to super reforms and the entry of Russell Investments’ survey in what was previously a very complex area dominated by Warakirri Asset Management.
Warakirri Asset Management head of investor solutions Andrew Nolan said Warakirri’s had been published quarterly since September last year, with after-tax performance data for some managers dating back five years.
Russell Investments director of after-tax investment strategies Raewyn Williams, in launching Russell’s after-tax survey last week, said the first results would be published for the year ended 30 June towards the end of August 2012.
Nolan said Warakirri’s after-tax performance numbers were calculated based on custodian level data – that is, holdings, transactions, corporate actions – and took capital gains tax (CGT) and also income tax and franking credits into account when calculating after-tax performance.
In contrast, Williams said Russell had “deliberately taken a simple, transparent approach to after-tax measurement – the franking piece we’ve included adds a lot to the meaningfulness of returns as measured and reported, and including franking is well understood and doesn’t require complex or controversial assumptions”.
She said the Warakirri methodology “is much more complex, broader in scope and reflects a custom measure for each manager. (It) covers realised and unrealised capital gains tax – not just franking credits – and adjusts each strategy for inception dates and cash flows”.
“It certainly has its uses, but we think it’s overly complex, contains too much information and not well-suited to a broad market survey,” she said.
In reply, Nolan said Warakirri’s research showed franking credits were not a reliable indicator of overall tax efficiency.
When considering the difference between before-tax outperformance and after-tax outperformance, the impact of CGT was significant, he said.
“Indeed, the difference between before-tax outperformance and after-tax outperformance can be significant,” he said.
“For institutional portfolios, the differences in after-tax performance can be millions of dollars: a difference of 0.5 per cent is $0.5 million on a $100-million portfolio.”
Williams said it was “short-sighted to overlook the impact of franking credits as they represent about 1.4 per cent of a large-cap Australian equities benchmark return each year. This is valued at around 70 basis points a year in additional returns to Australian equity super investors, yet is ignored in traditional surveys”.
For super funds in the pension phase, it was even more important to have a survey that captured franking credits.
“These represent about 140 basis points a year in additional returns (yield) for pension fund investors,” Williams said.
“Active Australian equity strategies can reasonably generate above-benchmark franking returns worth an additional 50 basis points to super investors, and more if off-market share buy-backs are on offer.”
Parametric managing director Scott Lawrence said: “International equities, like Australian equities, are subject to Australian capital gains tax and so the importance of after-tax investing is not limited to Australian equities.”
Parametric measured the after-tax returns of Australian and global equity portfolios, covering the MSCI All Countries World Index as well as other generally available equity indices.
In Australia, Lawrence said Parametric measured the after-tax portfolio and customised index returns for six of Melbourne-based industry superannuation fund Catholic Super’s active Australian equity managers.
Nolan said that frequently “a simple question will cut through all the noise”.
“When measuring investment returns from your personal portfolio of Australian shares, do you think just about franking credits and income, or also capital gains tax? We asked professional Australian equities managers if they take notice of whether a stock was purchased less than 12 months ago – to determine whether the CGT discount applies – in their personal portfolios,” he said.
“The answer was a consistent ‘yes’. Do you ignore capital gains tax when submitting your tax return? Of course you don’t. Does capital gains tax matter – yes, of course it does.”
