Tax-efficient investing by super funds increases member retirement savings
Nest egg could be more than 7% bigger if fund uses tax efficient investing
Super fund members are missing out if their fund fails to adopt an integrated tax efficient approach to equity investing, according to global implementation manager Parametric.
Parametric’s new research tracks the experiences of three hypothetical super fund members in two hypothetical funds that differed only in that one fund invested in a tax-aware rather than tax-naïve equity portfolio. The modelling shows that super funds that implement tax-efficient equity strategies could benefit their members with a maximum 7.2 per cent higher savings balance over a 40-year time horizon.
The research directly challenges a view sometimes proffered by consultants and commentators that tax-efficient investing does not benefit super fund members. The argument is that because accrued (future) taxes are deducted from member account balances, tax efficiency inside a super fund’s equity portfolio is like chasing “fool’s gold” with members unable to access the value.
Parametric’s research, by Seattle-based CIO Paul Bouchey, researcher Tim Li and Australian Managing Director - Research, Raewyn Williams, debunks this argument, showing that tax-efficient investing over the life of the member’s participation in the fund, including 10 years of receiving income from the fund after retirement, delivers better financial outcomes.
“In modelling the hypothetical members’ experiences, the lump sum balances accumulated after 30 years of contributions, as the first member prepares to retire, are 4.69 per cent higher if tax efficient investing has been continually practiced,” Bouchey and Williams say. “The extra savings from tax efficiency peak at 7.2 percent while all three members are in retirement.”
In the research exercise, Parametric establishes two competing sets of member account journeys - one exposed to an equity portfolio with a traditional pre-tax focus (ignoring the dividend and capital gains taxes that in fact apply to the portfolio); the other using a tax efficient equity portfolio that mirrors the first portfolio in all other respects.
Parametric compares the value of the different member accounts, using unit pricing rules, every year through a 40-year journey covering each member’s working life (30-year contribution phase) and retirement (10-year drawdown phase).
Based on each member contributing $10,000 a year for 30 years before retirement and drawing down $30,000 a year for 10 years post retirement, the result (net of fees and transaction costs) was that each member of the fund adopting tax efficiency practices was
almost $200,000 better off over this journey, as measured at unit-priced member option level, even after accounting for the impact of deferred taxes.
This establishes a clear link between a tax efficient equity portfolio delivering higher after-tax returns to a superannuation fund and higher savings for the fund’s members to help in retirement.
The research assumes the same income, growth and cashflow characteristics in each portfolio, but that the tax-aware equity portfolio halved turnover and prevented higher-taxed “short gains” from being realised in the portfolio. It did not specifically examine the impact of implementing through the innovative Centralised Portfolio Management (CPM) structure for which Parametric has become known in Australia.
The research shows that just before retirement, even after setting aside a provision for accrued taxes, the tax efficient fund had generated around $60,000 - $70,000 extra in each hypothetical member’s account – disproving the notion that tax efficiency inside a super fund does not improve member outcomes.
After around 10 years of retirement, looking back over the members’ journey with the fund, each member had earned almost $200,000 more than in the tax-naïve fund.
Bouchey and Williams say: “This is almost $200,000 more that members can use to meet their needs and aspirations in retirement and it’s wholly attributable to having a superannuation fund who practices after-tax investing in their equity portfolio.
“Along with our full research paper, we are happy to share our underlying modelling driving these results so funds and their advisers can verify these benefits for themselves.”
Parametric Portfolio Associates® LLC ("Parametric"), headquartered in the United States in Seattle, Washington, with Australian offices at MLC Centre, Suite 6502, 19-29 Martin Place, Sydney NSW 2000, is registered as an investment adviser under the United States Securities and Exchange Commission Investment Advisers Act of 1940. With over $230.1 billion USD of assets under management as of 31 December 2017, Parametric is a global asset management firm offering investors a variety of portfolio solutions, including tax-managed centralised portfolio management, tax-managed indexing and factor investing strategies, as well as emerging markets and defensive equities strategies. Parametric Australia is a division of Parametric Portfolio Associates® LLC that is a majority-owned subsidiary of Eaton Vance Corp, one of the world's most dynamic global asset management companies.
Opinions and estimates offered constitute our judgment and are subject to change without notice, as are statements of financial market trends, which are based on current market conditions. We believe the information provided here is reliable, but do not warrant its accuracy or completeness. This material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. Past performance is not indicative of future results. The views and strategies described may not be suitable for all investors. Investing entails risks and there can be no assurance that Parametric will achieve profits or avoid incurring losses. Parametric does not provide legal, tax and/or accounting advice or services. Clients should consult with their own tax or legal advisor prior to entering into any transaction or strategy described herein.
Charts, graphs and other visual presentations and text information were derived from internal, proprietary, and/or service vendor technology sources and/or may have been extracted from other firm data bases. As a result, the tabulation of certain reports may not precisely match other published data. Data may have originated from various sources including, but not limited to, Bloomberg, MSCI/Barra, FactSet, and/or other systems and programs. Parametric makes no representation or endorsement concerning the accuracy or propriety of information received from any other third party.
This material references simulated performance. It is hypothetical and does not reflect the experience of any investor. It is not intended to reflect a specific investment strategy offered by Parametric. The simulated performance reflects the deduction of management fees and transaction costs and the reinvestment of dividends. All investments are subject to the risk of loss.
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