Putting the cart before the horse on tax

Michael Houlihan

Investors can achieve much less from active Australian equity managers due to the tax component, new research by Vanguard Investments has found.

The average return from the 15 largest managers last year was 26.8 per cent, but for many this return was created by income that is taxable.

Vanguard manager of retail products Michael Houlihan said if an investor on the highest tax put $500,000 in a low efficiency (an active manager that has high portfolio turnover), the income tax on the return would be $49,081.

“This is because the manager achieved 5.4 per cent growth return and the rest as income return, which is taxable.

“This means the after tax return would be 17 per cent instead of the average 26.8 per cent.”

It was a similar story with medium efficiency managers (with 50 per cent short-term gains), who would pay $39,098 tax on a $500,000 portfolio, which would reduce the return to 19 per cent.

A high efficiency portfolio manager (with only long-term capital gains due to the low portfolio turnover) would have a tax payable component of $29,115, which would make the after tax return 21 per cent.

“Fund managers see returns as pre-tax yet the investors want after tax returns,” Houlihan said.

“This means many investors will have received their annual tax statements recently and got a rude shock when they realised what the tax impact of their fund distributions was.”

Using the same investment amount, and the same client profile, a Vanguard Australian equity fund returned 28.8 per cent last year, of which the income return was only 6.2 per cent.

Houlihan said this meant the income tax payable on the return was $11,891, which meant the after tax return was 26.4 per cent.

Vanguard has been campaigning for fund managers to publish after tax returns for investors as it does.

“This is an issue of transparency and investors should be able to get solid information before choosing to buy an investment fund,” he said.

Vanguard now has $65.3 billion of funds under management in Australia and is dealing with more than 5,000 financial planners, mainly through platforms.

According to Houlihan, $1.5 billion of that money has come direct from investors and $10 billion has also been sourced from offshore clients, mainly institutional investors.