The Real Story Behind Performance Numbers

Not all investment returns are created equal, imagine an investment returning 16% per annum, sounds impressive but if that return was created in a tax inefficient manner your 16% could quickly be reduced to less than 9% if that return was created with short term capital gains (assuming the highest marginal tax rate).

In fact a more modest return of 12% generated with long term capital gains will produce a superior real return 0.65% greater after tax considerations.

Yet, few investment managers or for that matter investment professionals fully investigate the tax consequences of investment returns.  It’s no industry secret that big brand fund managers don’t even consider tax when making buy or sell decisions, although tax is by far the largest investment expense and a major driver of real returns.

I would be negligent at the point not to mention that our investment philosophy is heavily influenced by tax considerations but why has the rest of the industry drifted so far from what could be considered an obvious strategy?  The reason stems two causes: (1) the highly individual effect of taxation and (2) most investment managers were established to manage pooled funds where investors with different taxation consequences are managed collectively, making it impossible to know the taxation effects of decisions let alone try to manage them.

Another important contributor to the ‘tax unaware’ of most mainstream manager is the effect of focusing on after tax returns can only be measured at an individual level and therefore the benefits can be as complex to measure as the tax regime itself, so instead most managers focus on the simple and easily measured headline returns, ignoring one the most powerful levers in creating real returns.

Kris Vogelsong, October 2011