It is critical to consider taxes within the asset allocation process, strategy implementation and asset location. The impact of taxes is likely to play a more important role in investor.
First, we incorporate the asset class tax characteristics during the portfolio optimization process.
Second, we incorporate specific manager tax efficiency characteristics into our due-diligence and manager selection process.
Third, we identify the most appropriate place in a client’s portfolio based on the return profile. For example, all else equal, a strategy expected to deliver 6% gross returns taxed as ordinary income will be less optimal for a high tax-bracket individual than a strategy expected to deliver 4% tax-free returns unless there is an ability to place in a tax-advantaged account. While these differences may seem subtle when looking at gross returns, the differences can be meaningful when evaluating after-tax returns.
Furthermore, within the equity allocation, we favor tax-efficient vehicles with the ability to add to returns through tax-alpha by harvesting losses while maintaining minimal tracking error to the benchmark. This tax alpha is correlated with volatility, so investors actually earn higher after-tax returns during volatile times. These harvested losses are used to offset income in other parts of the portfolio or carried forward indefinitely to offset future capital gains, a value that will increase with higher tax rates.
In collaboration with our Accounting Firm partners, valuable time is spent preparing and implementing tax effective strategies.