Tax
Accurate After-Tax Performance Returns Can’t Be Done To Scale - Yet.Â

The US wealth management sector uses a wide range of techniques to measure after-tax returns on portfolios. At a time when the tax bite on investments has become a more urgent concern, this article takes a look at the issue.
When taxes go up, and whatever approaches wealth managers take, clients will definitely want to know about where they stand once the tax bite hits. What will their portfolio look like after tax, and how can this be measured consistently? Those questions are not as easy to answer as they should be – so the author of the following article argues.
At a time when capital gains tax, income tax, and other federal and state levies appear to be headed up, this article is particularly timely. The author is Christine Madel, of Meradia. The firm, which was founded in 1997, provides strategic advisory and implementation services to the investment management industry.
A simple example might help to illustrate the issue. Every time someone sells a security, investors must pay tax on the difference between the purchase price and the sale price. If the sale price is greater than the purchase price, tax is owed and if the price is lower, this is a loss that can be used to cut capital gains or up to $3,000 of ordinary income. Anything that can’t be used in the current tax year can be carried forward to future years. Some wealth managers have told this news service that tax-loss harvesting - as the technique is used - has mixed results. During the massive stock market fall of March 2020 when the pandemic-related lockdowns took hold in the West, anyone who had used this tactic would have had to scramble back to repurchase assets - losing the tax benefit - when markets subsequently shot back. Creating reliable measures of how effective such techniques are over time is not straightforward.
We hope readers find this article useful. Jump into debate with responses. The usual editorial disclaimers about bylined commentary apply. To respond, email the editorial team at tom.burroughes@wealthbriefing.com and jackie.bennion@clearviewpublishing.com
(Details on the author below.)
As a wealth manager, you spend a great deal of time servicing clients and perhaps even more time explaining the results in a meaningful way. Clients consistently want to know how their portfolio is doing, how they are meeting their financial goals, but they also need to understand the impact of taxes.
When it comes to demonstrating after-tax performance, the advisor may not have the right information to clearly articulate to the clients how their investments are performing on an after-tax basis. For high net worth and ultra-high net worth clients who have multiple investment portfolios, complex investments and often have low-basis investments, understanding the after-tax performance is especially valuable but also the most difficult to measure.
Calculating the after-tax performance of the client’s total investment portfolio is possible; however, the means of doing so requires a holistic methodology that incorporates inputs from disparate systems and documents, and can account for adjustments as more information becomes available.
After-tax performance reporting today
The methodologies firms use today for after-tax returns are
imperfect due to the narrow focus rather than holistic view, the
plethora of client information that factors into the calculation
and the inability of systems to store that data. In addition,
changes to the federal, state and local tax code make it
challenging to maintain correct formulas. Even when the advisor
has complete transparency into the client information and the tax
implications are known, there is still the matter of timing. Only
estimates are available during the calendar year with final tax
code rules and the client’s marginal tax rates known after the
fact.
This has a negative impact on the advisor in several ways. First, they are unable to demonstrate tax-sensitive trade and portfolio construction decisions that incorporate both managed and non-managed investments. When pressed for after-tax information, advisors must rely on manual and error-prone processes that reduce efficiency. Lastly, it requires the client to provide this information, which is often presented in an irregular manner and without a centralized aggregation tool.
Though some may argue after-tax benchmarking is a necessary part
of performance reporting, others argue that it’s more applicable
to investment managers who are strictly providing investment
services for a subset of the client’s portfolio, or for firms
providing algorithms to perform tax-optimized trading decisions.
Those taking this counter-view assert that the wealth manager’s
focus is on meeting their client’s goals and helping them
navigate their unique financial circumstances. This may involve a
single portfolio but, more often, includes qualified plans and
illiquid investments which are not part of the data set used for
a stand-alone analysis.
Expectations for evolution
At the end of the day, the client’s primary objective is to
minimize the annual tax burden of their investments as a whole.
Taxes are the largest expense for a taxable portfolio and hinder
the ability to meet personal goals, which can include generating
income and saving for retirement. After-tax returns provide the
client with information about the portfolio’s performance
relative to personal goals:
-- Did it produce the income needed to meet expenses? Is it
growing enough to meet retirement needs?
-- From the wealth manager’s perspective, the key objectives are
to demonstrate the value of their process to justify fees and
demonstrate competitive advantage; and
-- With the need for after-tax performance, how might the
industry evolve to produce more accurate and scalable
information?
1. Automate client data collection – There is a huge opportunity for artificial intelligence to be utilized for gathering client information from tax documents and held-away assets, such as real estate or private equity investments that complement the information specific to the managed assets. For example, how many investors are sharing comprehensive tax details with an advisor who is running just a portion of their portfolio? Automation tools must be able to do overrides to account for changes between tax brackets. For accurate analysis, clients must be willing to provide this information, and have it captured efficiently and securely.
2. Explore possibilities for system integration – Client data software should be able to interact with accounting and performance tools to create after-tax results. This will help eliminate assumptions within the dataset and accelerate adjustments and re-reporting.
3. Create a transparent portal - As with any reporting tool, transparency is key to seeing where results came from, showing what was in the calculation and allowing for retroactive changes.
The systems used today to generate after-tax performance returns lack the key ingredients required to offer a true and accurate glimpse of an individual’s actual circumstances. It’s not a math problem – it’s a data input problem. We want to demonstrate that we are able to reduce the client’s tax burden, but the way we get there is not available today. Moving forward, wealth managers should keep an eye out for tools that address the underlying data issue.
About the author:
Christine M Madel, CFA, is a Principal Consultant at Meradia with more than 30
years of experience in the wealth management industry. She
leverages her deep business and technical experience, project
management acumen and relationship-building skills to solve
complex challenges for clients. Tina specializes in leading
client reporting initiatives, establishing processes for
normalizing and cleansing portfolio/trust/market data,
performance system conversions and client portal implementations.
Tina has served numerous registered investment advisors, trust
companies, asset managers and multi-family offices.