Increase investment returns through real-time tax management

By Christopher Madpak, SS&C Technologies

Published: 28 November 2022

Five key criteria for a technology solution

Investors look to fund managers to deliver optimal performance in any market conditions. Over the past decade, however, it has become increasingly difficult to consistently outperform the market. In the search for structural alpha, many managers may be missing an opportunity to add incremental percentage points to their returns through tax-efficient investment strategies.

Along with asset allocation and security selection, taxes are among the most influential factors in portfolio performance. Experienced investors know this. They are increasingly tax-aware and expect their managers to pursue strategies to optimise their tax positions. At some point in due diligence or in fundraising pitches, a fund manager must be able to answer the question: “What are you doing to be tax-efficient?” Managers able to demonstrate a systematic approach to tax-efficient investing stand to gain a significant competitive advantage.

The essential ingredient: reliable data

Diligent tax-efficient investing requires access to real-time portfolio data and advanced analytics capabilities, enabling managers to run ‘what-if’ scenarios to evaluate more precisely the tax impact of investment decisions before executing them. Many firms lack the necessary access to data and analytics. Those trying to be tax efficient are left to rely on stale data aggregated from multiple systems or vendors and spreadsheet-based calculations, yielding less-than-reliable forecasts. As a result, whether by a lack of effort or a faulty methodology, many firms are leaving a substantial percentage of potential returns on the table.

CPA firms, auditors and tax advisors can help you minimise your tax obligations within legal bounds, but they are not in the business of helping investment managers optimise returns. They might be able to help identify the sources of tax drag after the fact, but they do not have the data infrastructure to deliver real-time, reliable, actionable data to support proactive tax impact analysis.

What’s needed: a smart technology solution

Not surprisingly, fund managers serious about tax efficiency are looking to technology for help. So what would the optimal technology solution look like? To support both tax-efficient investment decisions as well as timely and accurate tax reporting and filing, the solution must meet five key criteria:

A single source of truth: The first requirement is to make all portfolio and transaction data needed for tax reporting, compliance and analysis accessible through one system. Too often, the data needed to prepare tax filings is spread among several siloed systems and never aggregated until the filing season. Centralising data on a single platform and eliminating data redundancies and inconsistency is the first requirement of a tax-smart solution.

Process integration: Similarly, all the processes related to tax reporting and compliance should be integrated in one system, rather than run in isolation and ‘handed off’ from one system to another.

Intelligent automation: Today’s advanced automation technologies raise the bar for speed and accuracy, helping ensure data integrity and process efficiency. With a single, integrated platform powered by smart technology, firms can eliminate cumbersome offline workarounds and manual intervention and free people to spend less time processing data and more time analysing it.

Advanced analytics: With all the necessary data centrally organised and accessible, firms then need tools to leverage their data and derive insights from it. Advanced analytics capabilities are critical. Powerful analytics enable managers to deliberate alternative scenarios more quickly and thoroughly to better understand and manage their tax exposure all year-round – not just at tax time.

Investor-level tax analysis and reporting: The same solution supporting the fund manager’s decision-making should also help communicate the tax benefits of the manager’s strategy to investors. It should deliver data and analysis to help investors understand their own tax exposure and meet their tax reporting obligations accurately.

Improve performance while reducing tax liability

The ability to manage a fund’s tax exposure year-round has a number of potential benefits. It enables a firm to maximise structural alpha, or consistent after-tax returns in excess of designated benchmarks, through data-driven, tax-efficient investment strategies. At the same time, it can help minimise the overall tax impact on a fund and its investors while enabling the firm to meet its tax compliance obligations efficiently, accurately and in a timely manner. Moreover, the ability to demonstrate a systematic approach to tax-efficient investing and communicate its benefits to investors can help fund managers strengthen relationships, engender loyalty and increase retention.

In sum, tax-efficient investing can improve returns significantly and confer a competitive advantage with differentiated strategies. Today’s intelligent technologies make it possible for investment managers to easily incorporate tax strategies into their everyday decision-making processes, while simultaneously mitigating the annual tax bite.