PORTAX After-Tax Portfolio Analysis

Large investor portfolios consist primarily of managed assets.  Managed assets typically consist of multiple investments that a manager buys and sells during a year.  This turnover converts unrealized gains and losses into realized gains and losses and creates tax events for the investor.

Investors with multiple year horizons benefit from a passive or low turnover policy in that unrealized gains are reinvested as opposed to creating taxes from realized gains.  An active or high turnover policy only benefits an investor if the manager can generate excess return to compensate for the tax effects.

The graph to right shows three different turnover strategies for an initial $1 million investment.  The expected capital appreciation is 8%, the tax rate is 40% and the investment horizon is 10 years.

The last column in the corresponding table to the right shows the excess return that the manager needs to generate to compensate the investor for the tax effects of increased turnover.  For the active strategy, the manager needs to generate 3.3% excess return or a total return of 11.3% to match the passive strategy.