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December 9, 2019

Fundamental Indexing: Why True Tax Efficiency Beats Simply Keeping Turnover Low

There is a pervading misconception at the heart of the active-passive investment debate: that simply moving from an active to passive equity management style gives a superannuation fund the tax efficiency it seeks. This fails to appreciate what the opportunity set to manage taxes on an equity portfolio really covers, instead reducing tax efficiency to a simple, misleading ‘keep turnover low’ mantra.

In this paper we put this idea to the test using Research Affiliates’ pioneering approach to building a passive equity portfolio known as ‘fundamental indexing’. After covering the shortcomings of the ‘keep turnover low’ approach for an after-tax-focused super fund investor, we show how after-tax thinking should inform portfolio design and implementation. 

Using as our exemplar portfolio the Research Affiliates fundamental indexing (RAFI) approach, we build on our previously published research applying intelligent tax management to a range of market-capitalisation-weighted and factor-based equity portfolios. We establish a useful principle for super funds—that our method of adapting equity portfolio approaches to an after-tax investing philosophy can be applied to most, and perhaps all, kinds of listed equity portfolios.

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Raewyn Williams

Head of Research
Australia & New Zealand

+61 434 372 210
Raewyn Williams