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Tax Implications of Active Equity Management Performance

Data has shown that it’s challenging for active investment managers to beat the S&P 500 Index, even more so when fees and taxes are taken into consideration. With patience and discipline investors can enjoy the rewards of capital appreciation without realizing significant capital gains.



“It's not how much money you make, but how much money you keep, how hard it works for you, and how many generations you keep it for” – Robert Kiyosaki

A review of active, equity management performance suggests that manager selection is challenging.  Investors should proceed cautiously and not forget to consider tax implications.  It is debated when both fees and taxes are taken into consideration, whether active management can beat the market.  When evaluating a large sample of money managers, it would appear that most fail to deliver market beating performance after fees and taxes are evaluated.

However, Curran’s Core Growth Equity strategy has stood apart throughout its history.  Curran has been a top-performer offering market beating returns after fees and has consistently been among the top quartile among its peers.  At Curran we have generally enjoyed market beating performance after fees over both short and long-term periods.  Using the eVestment database of over 400 large cap core equity strategies, Curran’s Core Growth ranks in the top quartile of its peers across 1, 3, 5 and 10 year periods as of June 30, 2019.

In 2018, S&P reports that over 60% of large cap equity funds failed to beat the S&P 500.  The numbers are worse over longer periods with over 75% of strategies failing to beat the S&P 500 over 3 years.  Complicating analysis over even longer periods, columnist Mark Hulbert points out in a 2018 MarketWatch article that 34% of large cap funds from 15 years ago no longer exist, having closed, returning money to investors or having merged with other funds.  Curran’s Core Growth Equity's record now stretches back over 20 years.

Performance alone should not be the only consideration for investors, particularly those with taxable accounts.  The Morningstar Tax Cost Ratio measures how much a fund's annualized return is reduced by the taxes investors pay on distributions. Mutual funds regularly distribute stock dividends, bond dividends and capital gains to their shareholders.  Investors then must pay taxes on those distributions during the year they were received.

According to Morningstar the average tax-cost ratio for equity funds tends to fall between 1.0 and 1.2.  Like an expense ratio, the tax cost ratio is a measure of how one factor can negatively impact performance.  Also, like an expense ratio, it is usually concentrated in the range of 0 - 5%.  0% indicates that the fund had no taxable distributions and 5% indicates that the fund was less tax efficient.  A fund with a ratio of 1.0 would reduce the strategy’s total return by 1.0% when taking taxes into consideration.  

Analysis as of 6/30/2019


10 Year

5 Year

3 Year

1 Year

Curran Rep Acct A before taxes - net

15.16%

10.89%

17.39%

16.35%

Curran Rep Acct A after taxes - net

14.19%

10.50%

17.13%

16.42%

Curran Tax Efficient Morningstar Tax Cost Ratio

0.84

0.35

0.22

-0.06

VFINX - Vanguard 500 Index Fund before taxes

14.54%

10.56%

14.04%

10.27%

VFINX - Vanguard 500 Index Fund after taxes on distributions

14.09%

10.06%

13.53%

9.76%

VFINX - Vanguard 500 Index Fund Tax Efficient Morningstar Tax Cost Ratio

0.39

0.45

0.45

0.46


The above chart compares a Curran Core Growth representative account with the largest index fund in the world, Vanguard's passive and tax efficient, Vanguard 500 Index Fund.  At Curran, we have generally done a very good job by outperforming the benchmark S&P 500 Index vehicle, particularly over the last three years.   Across all periods Curran outperforms the index fund both after fees and after taxes.  In addition, Curran’s Core Growth representative account has managed to be more tax efficient as measured by Morningstar than the Vanguard 500 Index Fund over the rolling 1, 3 and 5 year periods.  In fact, over the last year the account  resulted in no realized capital gains, while the index fund lost (0.46%) of its total return due to taxes.  Over the last 10 years, we can state that Curran has been tax aware in its management of Core Growth Equity.  

Data has shown that it’s challenging for active managers to beat the S&P 500 Index, even more so when fees and taxes are taken into consideration.  While there will be times when Core Growth is out of favor, our results illustrate that patient investors will be rewarded for holding the best quality companies over many years rather than pursuing a more actively traded approach with high portfolio turnover.  Active trading increases costs and high portfolio turnover generally increases realized capital gains.  With patience and discipline, investors can enjoy the rewards of capital appreciation without realizing significant capital gains.

Sincerely,

https://static.twentyoverten.com/5a4258bbacdea1742455dc1d/lcyhGyDmsIx/1554930607886.png

Kevin T. Curran, CFA
President & Chief Investment Officer
Curran Investment Management® is Defining Quality®

Please check with your Curran Wealth relationship manager,
or contact Curran Wealth Management if you have any questions.
 518.391.4200 •
info@curranllc.com

The material contained in this article is for educational and informational purposes only.  The information herein is considered to be obtained from reference sources deemed reliable, but no representation or warranty is made as to its accuracy or completeness. It is not, and should not be regarded as “investment advice” or construed as a “recommendation” or an offer to buy or sell a security.  CIM, LLC does not provide tax or legal advice.  No one connected with CIM, LLC can ensure tax consequences of any transaction.  The information contained in this article may not apply to your personal circumstances.  Before making any decision or taking any action, you should consult a professional advisor who has been provided with all pertinent facts relevant to your particular situation.