Showing performance advantages through active tax management strategies

Monday, August 2, 2021 | By Mark Elliott, Director & Head of Performance and Attribution Solutions, SS&C Institutional & Investment Management

Showing performance advantages through active tax management strategies

Investment in US exchange-traded funds (ETFs) broke new records in 2020, with inflows exceeding $500 billion for the first time and topping the previous year’s record by 55%. Last year’s advance capped more than a decade of steady growth for passive mutual funds and ETFs, many built to track indices. Much of that growth came at the expense of actively managed mutual funds, which saw outflows virtually equivalent to passive fund inflows over the same period.

In buoyant markets, passive strategies deliver returns that the average retail investor would consider quite acceptable, with little risk and low costs. For those investors, there is little point in paying a premium for actively managed portfolios that cannot significantly outperform the market.

How, then, do active wealth managers compete against this trend and deliver superior results? The starting point is with active management—construct a portfolio that outperforms the passive alternative—but over the long term, this has proven difficult to accomplish, especially on a net-of-fees basis. The use of Separately Managed Accounts (SMAs) combined with active tax management strategies can give a boost to performance.

One key advantage of SMAs over passive funds lies in their ability to leverage tax loss harvesting opportunities—minimizing tax liabilities and maximizing after-tax returns, which is what really matters to holders of taxable accounts. 

For firms to offer after-tax management, the first tool required is a portfolio accounting solution with built-in functionality that enables portfolio managers to easily identify the appropriate positions to sell. The second tool needed is a complementary performance attribution solution that accurately measures the performance of the clients’ accounts on an after-tax basis. It is also important to be able to measure an after-tax benchmark return to compare against the portfolio. This benchmark should approximate the after-tax return of the passive alternative and could be used to show clients and prospects the benefit of the tax-aware strategy.   

Passive investing strategies may suit the needs of the mass retail market, but substantial investors who rely entirely on passive approaches are missing opportunities to outperform the market by optimizing tax strategies. A tax-managed SMA offering can provide a competitive advantage over low-cost, tax- unaware alternatives. The key is having the right tools to build, manage, monitor and report on tax-managed SMA strategies, and then to show clients why and how such strategies produce better results for them.

For more on this topic, please download our "Meeting the Operational Challenges of After-Tax Performance Measurement" whitepaper.

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