An enormous body of academic finance literature discusses the pre-tax performance of public equity factor tilts, but almost nothing measures the impact of taxes on taxable asset owners. Pete Hand, Aperio’s Director of Quantitative Strategies, has remarked over the years that pretty much every paper in academic finance needs to be rewritten from the standpoint of the taxable investor. And David Swensen, Yale University’s legendary CIO, calls the management of taxable mutual fund assets without considering the tax consequences of trading activity “a highly visible, yet little considered scandal.” We would extend Swensen’s comment to include the management of all taxable assets, including those in separately managed accounts (SMAs), not just those that happen to be in a mutual fund wrapper.
In developing a quantitative investment strategy, a money manager will often “back-test” different strategies in order to see how it might have performed during different historical time periods. This is a fairly straightforward process on a pre-tax basis as sophisticated back-testing tools are commercially available to help run the simulations. Unfortunately, to the best of our knowledge, we know of no such tools that are commercially available which can simulate and measure the historical impact of taxes. As a result, Aperio has spent the past three years developing a very flexible and broad-based back-testing platform that is now the foundation for our public equity analyses across the board. We believe it is one of the only tools available that allows for after-tax back-testing. Called the After-Tax Back-Testing Analysis Tool, or ATBAT for short, the platform....
Allows for after-tax optimization and performance measurement.
Allows for multiple starting points for strategy testing, which is critical for processes that are path dependent (every tax-managed portfolio is path dependent!).
Can analyze multiple separate but equivalent back-tests, including cross-sectional studies (comparing portfolios as of specific point in time—for example, tax alpha in 2008—regardless of back-test start date) and longitudinal simulations (comparing portfolios across time; for example, cumulative tax alpha in years one to 10).
Works with a wide variety of risk models, benchmarks, and Aperio or client-defined investment strategies while maintaining precise accounting of tax outcomes at a tax-lot level.
Has a custom-built process for organizing and visualizing results along either calendar or vintage time dimensions, each of which is very important for taxable investors.
Perhaps most importantly, helps advisors manage client expectations better by creating a range of expectations (due to the use of multiple paths) pre- and after-tax, based on empirical back-tests rather than just a simple summary using average or median metrics.
With ATBAT, we have a new research platform that we can use to test investment decisions, such as gifting strategies and factor investing, in a taxable environment, as well as the impact of tax law changes at the state and/or federal level. Most recently, we used ATBAT to quantify the potential impact on our client portfolios of the proposed Senate tax reform bill changes that would disallow specific lot identification and instead require the FIFO (first-in, first-out) method.
As the recent congressional tax proposals remind us, the investment environment can change very quickly and nothing is for certain. The best we can hope for is to make informed decisions as quickly as possible, and ATBAT is a powerful new platform at your disposal.
ATBAT (Aperio After-Tax Back-Testing Analysis Tool) analyses are generally only available to financial professionals, and one should use caution when considering this information. ATBAT, as a tool-based platform, is inherently limited in its ability to reflect the actual results regarding performance and other quantitative information that may have been, or will be, achieved by any given portfolio. Aperio, like all investment advisors, has an incentive to present returns that reflect positively on Aperio’s investment strategies. While Aperio seeks to apply the application of ATBAT objectively and consistently, Aperio may be unsuccessful in removing all instances and forms of bias from the construction and implementation of the tool. There is no guarantee that any client results actually achieved will align with the modeled results demonstrated or output by ATBAT.
ATBAT may have fundamental errors and may produce inaccurate outputs when viewed against its design objective and intended business uses. The mathematical calculation and quantification exercise, for example, underlying the models embedded in ATBAT generally involves the application of theory, choice of sample design and numerical routines, selection of inputs and estimation, and implementation in information systems. Errors may have and can occur at any point from design through implementation. In addition, shortcuts, simplifications, or approximations used to manage complicated problems could compromise the integrity and reliability of outputs from those calculations. Finally, the quality of the outputs from ATBAT depends on the quality of input data and assumptions, and errors in inputs or incorrect assumptions will lead to inaccurate outputs. Even assuming that ATBAT is a fundamentally sound tool, producing accurate outputs consistent with its design objective may still exhibit high risk if it is misapplied or misused. Such modeling tools, by their nature, are simplifications of reality, and real-world events may prove those simplifications inappropriate.
ATBAT’s results aim to reflect Aperio’s tax-loss harvesting strategy. This strategy seeks to enhance the returns of an equity index–tracking portfolio by selling a basket of stocks to realize tax losses and buying a replenishment of stocks with similar risk characteristics, so that the rebalanced portfolio continues to track its benchmark.
This material is provided for informational purposes only and is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are subject to change at any time without notice. References to specific securities, asset classes and financial markets are for illustrative purposes only and are not intended to be and should not be interpreted as recommendations.
This material may contain “forward-looking” information that is not purely historical in nature. Such information may include, among other things, projections, forecasts, estimates of yields or returns, and proposed or expected portfolio composition. Moreover, any historical performance information of other investment vehicles or composite accounts managed by BlackRock, Inc. and/or its subsidiaries (together, “BlackRock”) included in this material is presented by way of example only. No representation is made that any performance presented will be achieved, or that every assumption made in achieving, calculating or presenting either the forward-looking information or the historical performance information herein has been considered or stated in preparing this material. Any changes to assumptions that may have been made in preparing this material could have a material impact on the investment returns that are presented herein by way of example. Past performance is no guarantee of future results.
The information and opinions contained in this material are derived from proprietary and nonproprietary sources deemed by BlackRock to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy.
Aperio is providing this link to a third-party website that displays a research report, article, webcast, video, or other content that we believe may be informational or educational for you. This linked content is presented by a source that we believe to be reliable, but we do not guarantee its accuracy or completeness, including any associated disclosures. Aperio has no control over the nature of the content on, or the availability of, this third-party website.
The inclusion of this link on our website also does not imply a recommendation or endorsement of any views expressed in such linked content and should not be considered: investment, tax, or legal advice; a solicitation; a recommendation of Aperio or any third-party’s services; or an offer to buy or sell any securities or related financial instruments in any jurisdiction.
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