“It’s about time”: The move to after-tax investing

Changes recommended by the Cooper review to the Superannuation Industry Supervision (SIS) Act 1993 will accelerate the trend to after-tax investing and according to Raewyn Williams, “it’s about time”.

Williams, director of after-tax investment strategies at Russell Investments, says the industry remains fixated on pre-tax outcomes, despite growing investor interest for after-tax investing (ATI) outcomes.

A low level of awareness around ATI means the real impact of tax on investment returns is not being properly acknowledged. Cooper has addressed this issue in its government-supported recommendation that funds must recognise taxation consequences in the development and implementation of an investment strategy.

Returns to investors can be significantly reduced by tax if a fund manager isn’t conscious of the tax implications of its actions. For example, a decision to delay the sale of an asset to take advantage of discount capital gains tax may have negligible effect on the pre-tax return, but lead to a significantly better after-tax return for an investor.

Asset consultants Towers Watson (TW) says the “tax drag” from investing in Australian equities can vary, as outcomes are dependent on the class of investor and the type of portfolio they hold.

According to their latest research report, After-Tax Investing in Australian Shares, there are a number of strategies that portfolio managers can utilise to enhance after-tax returns such as reducing stock turnover in line with the proportion of nominal gains, ‘harvesting’ franking credits and participating in off-market share buybacks.

Russell’s Williams says financial planners will be attracted to after-tax products as the strategies are not difficult to understand conceptually. But she has warned that investment products claiming to focus on after-tax returns may not all be equally effective.

“We’re just starting to have those outward conversations with the rest of the market,” says Williams.

“I think one of the challenges is that we’ve made it accessible and we don’t like to complicate the message to the people that will be interested in the product, but yet we have to be technical about it.

“The complexity is actually the data build from the custodian and the judgment we do in the way we execute.

“We think that when we take this around to advisers and that market, they’ll be able to get their heads around what we’re doing.”

Williams has been wary of the possible implications of an after-tax focus. She says the old adage still holds true: never make an investment decision based on tax considerations alone.

“It’s not about tax minimisation or harvesting franking credits or always accessing a capital gains tax discount,” Williams says says.

“We’ve been very careful to make sure that tax doesn’t drive investment thinking; it should inform it.

“The idea is to have tax in the mix amongst a lot of other factors that have nothing to do with tax so you can never point to anything we do in the fund to just solely generate a particular tax outcome.

“That’s the way to manage the issue of tax risk and if you don’t get that balance right then you do create risk in the fund.”

This highlights a concern for new competitors emerging in the after-tax space.

“They’ll see this product being successful and then they’ll put together something that might look good on the outside and is ‘after-tax’,” Williams says.

“But [it mightn’t] actually have nearly as much sophistication behind it and goes for those inferior strategies like keeping turnover low, always.

“That sort of simplicity has a seductive message – if you can dumb a tax strategy down into a really simple message, people will want to believe it because they understand it.”

Williams says it will only be a matter of time before the industry recognises the benefits of after-tax returns.

“Everyone’s scared or perhaps has a vested interest in keeping pre-tax because it’s done pretty well on that basis.

“But the issue is, as we see people moving into this space, there will be a vast difference in quality [of products].”

Williams says Russell Investments is “into solving these complex problems”, having just launched their Russell After-Tax Australian Shares Fund (for superannuation Investors) on February 1, to provide a “totally bona fide after-tax return”.

“Seeing a gap in the market, seeing something that’s not being offered and a whole heap of investor demand for it … we’ve really tried to leave no stone unturned in terms of what could we do in this space for superfund investors.”

The distributing fund, with pooling and scale benefits, aims to heighten the visibility of after-tax outcomes by integrating tax awareness into the overall investment process.

It aims to achieve effective after-tax investing using Russell’s in-house emulation capabilities and the insights of multiple managers, creating lower turnover, lower transaction costs, higher performance, preserved manager capacity and improved tax efficiency.

“What we wanted to do was not throw out what’s good about a distributing fund but bringing it into the modern world,” Williams says.

She believes the new fund is “a solution in the middle, that’s what we’re offering”.

“We didn’t want to just put the first thing out on the market, we wanted to offer something that sets the bar really high.

“Even if it’s costly, if the net benefit makes it worthwhile, we’ll do it so long as it ensures that our superfund investors will be going forward on an after-tax basis.”