Tax a blind spot when funds adjust strategies

Superannuation funds need to remember to consider the tax implications when readjusting their investment portfolios as many solely focus on timing and transaction costs, according to Parametric.

The implementation specialist manager’s managing director of research (Australia) Raewyn Williams and analyst Joshua McKenzie, said the hidden costs of “tax-naïve” transitions would add up and be felt in members’ pockets.

“A fund’s goal should be to extract as much value as possible from every new or necessary investment idea in its new target or destination portfolio, instead of seeing this value paid away to third-party brokers, traders, managers, funds and the taxman as the expensive price of getting there,” they said.

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“When it’s considered that funds are liable to a 15% headline tax and can benefit from franking credits, it seems logical to assume that super funds would carefully consider the tax implications of any transaction involved in readjusting a portfolio. But this is usually not the case.”

Williams and McKenzie said scenarios that funds and transition managers needed to be aware of investment tax risks inherent in equity transitions included:

  • Selling out of cum-dividend legacy positions without considering the value of accrued franking credits not priced into equities;
  • Selling out of ex-dividend legacy positions in a way that causes loss of franking credits received;
  • Selling out of legacy positions before the trade qualifies for tax concessional treatment of capital gains; and
  • Allocating tax lots to the legacy trades which trigger higher capital gains or lower capital losses than other tax lots would have triggered.

“Franking credits can be protected by managing the timing of ex-dividend and cum-dividend stocks; capital gains can be managed by delaying a transition of short-term holdings, intelligent tax lot selection and widening the tax lot optimisation universe,” they said.

“More broadly, sector and factor risk optimisation techniques can help to define the legacy and target portfolios in a transition based on risk characteristics.”

Williams and McKenzie noted that tax-aware transition practice required the right structure, operational process, tax lot information, and skills to balance tax thinking with other dimensions of transition management.

“Tax concerns should not drive how equity portfolio changes are implemented, but surely we can do better than just ignore tax costs completely,” they said.

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