Continual Tax Management

Sometimes “investment returns at any cost” is the approach used by investment managers, brokers and advisers. While this cavalier approach can be employed by the investment manager in different ways, one way is when there is no consideration of the tax impact on the portfolio when investment decisions are made. In fact, some opinions have suggested if there is no consideration of the tax cost to a portfolio the total rate of return could be decreased by 2% to 3% depending upon the tax bracket of the portfolio owner and other tax-related criteria.

At Matthai Capital we work with every client to customize their portfolio so that it reflects their investor profile and the specific pool of money. This customization includes whether or not taxes are a consideration. If they are, we have a number of different tools and techniques we utilize in order to minimize the tax impact on the portfolio.

One example of the tools we use is Tax-Managed Mutual Funds which utilize one or more of the following techniques to minimize the taxable consequences on their shareholders:

Loss Offset
This is the simplest form of tax management and one employed by many mutual fund companies. One example would be if a manager sells IBM at a gain and then looks for another stock in the portfolio they can sell at a loss to offset the gain.

Tax-Aware Trading
This is a more sophisticated tool than loss offset. The tax-aware manager looks at alpha (the incremental added return) of a stock transaction in conjunction with taxes. For example, if a manager currently has Compaq in the portfolio with an expected return of 20%, the expectations are that a like company (Dell Computer) will return 25% over the next year. The tax-aware manager will only sell Compaq and buy Dell if the tax consequences of this transaction can be overcome by greater performance from Dell.

Loss Harvesting
This is the most sophisticated method of tax management. The loss-harvesting manager looks at taxes as a new component of alpha. This type of manager can be viewed as a manager that looks at lot by lot the tax impact of a trade. For example, if the manager currently holds Compaq with an expected return of 20% but currently holds it at a loss, the manager could substitute Dell into the portfolio at an 18% return and harvest the loss from Compaq for later use. In essence, the manager hasn’t altered the structure of the portfolio, but has harvested the loss with a greater incremental value.

In addition to this form of tax management, George Matthai, on an ongoing basis, will discuss with the client potential tax-efficient changes to the portfolio. For example, he would not only recommend a Tax-Managed Mutual Fund for a tax-conscious portfolio, but he would also consider the tax cost (capital gains) to the owner of the portfolio if he should sell that fund or another fund in the portfolio. When appropriate, he might even recommend some of the same techniques employed by the Tax-Managed Mutual Fund managers to the assets within the overall portfolio.

The bottom line is Matthai Capital does not believe in “investment returns at any cost”, rather we choose to consider the cost as we seek to achieve the returns for our clients’ taxable portfolios.