OUR POINT OF VIEW
ADVANTAGES OF INDEXING 2
APERIO GROUP, LLC
Three Harbor Drive, Suite 315, Sausalito, CA 94965
Phone: 415.339.4300 Fax: 415.339.4301
ADVANTAGES OF INDEXING
Active managers have consistently under-performed
passive benchmarks pre-tax. Over the long-term, the
broad market indexes such as the S&P 500, Russell
3000, and Wilshire 5000 have beaten about 65-80%
of active equity managers’ pre-tax return, depending
on the time period. According to David F. Swenson,
Chief Investment Officer, Yale University, in his book
Pioneering Portfolio Management, the median active
U.S. equity manager gives up about 0.35% (after fees)
per year relative to the benchmark, while a manager
needed to exceed the benchmark by only 0.85% per
year in order to be in the first quartile.
Because active managers tend to be extremely tax-
inefficient, when comparing after-tax returns active
managers fare much worse due to their high fees
and tax-inefficiency. Taxes are single-handedly the
largest drain on portfolio performance, dwarfing both
management fees and trading costs. Depending on
portfolio turnover, taxes can consume as much as
50% of annual return.
WhAt Is IndExInG?
Indexing is an investment strategy that seeks to match the
performance of a particular asset class as measured by an index by
investing in all or a representative subset of securities comprising
WIth IndExInG, dOn’t I jUst sEttLE fOR AvERAGE PERfORmAnCE?
Indexing provides consistently above-average returns, as shown by
numerous research studies on equity mutual funds. Over the long-
term the Russell 3000 Index has beaten about 65-80% of active
equity managers’ pre-tax returns, depending on the time period. When
comparing after-tax returns, active managers fare much worse due to
their high fees and tax-inefficiency.
Why shOULd InvEstORs CARE AbOUt tAxEs WhEn EvALUAtInG
Money managers rarely calculate after-tax returns and most portfolio
management systems are not equipped to measure the impact of
taxes. Yet, while high pre-tax returns help portfolio managers win
performance rankings, taxable investors get to keep only a portion
of that return. Studies have shown that taxable investors typically
surrender 2-3% of portfolio return to federal taxes. The combination
of tax drag and poor performance (active managers typically under-
perform their pre-tax index benchmarks by more than 1.5%) makes
active management a poor alternative for maximizing after-tax returns.
hOW CAn APERIO’s CLIEnts UsE thE bEnEfIt Of A REALIzEd LOss?
Realized losses can be used by investors to offset the same value of
realized gains, including gains from other portfolios or gains that are
the result of selling low-basis concentrated stock holdings.
dOEs APERIO’s mOnEy mAnAGEmEnt sERvICE LOWER my RIsk?
Yes. Aperio customizes its portfolios around existing client positions.
The result is a portfolio with lower risk versus the original concentrated
security portfolio and superior control over taxes.
Why dOEsn’t EvERyOnE IndEx?
Human nature causes many investors to overestimate their abilities to
“beat the market”. Though indexing has been used by large institutions
since the early 1970s, it has only been in the last decade that the
benefits of indexing has received significant attention by individual
investors and the media.
Isn’t IndExInG jUst PLAIn bORInG?
dOEs APERIO EmPLOy tAx AWARE stRAtEGIEs In Any OR ALL Of
yOUR PROdUCts, And WhICh PROdUCts RECEIvE thE stRAtEGIEs?
Aperio employs tax aware strategies in all of its products. Aperio has
specifically designed its portfolio management system to manage for,
and report, after-tax returns.
shOULd I ExPECt hIGh OR LOW tURnOvER fOR An ACCOUnt
mAnAGEd by APERIO GROUP ?
Since our strategy is specifically targeted toward generating tax losses
while tracking a pre-tax benchmark, our turnover tends to be high, but
for most clients almost all transactions are targeted toward generating
losses with no realized gains. Unlike active management, which may
add tax awareness onto an existing strategy, our strategy is built on
maximizing losses and minimizing gains. Thus a tax-loss maximization
strategy leads to initially high turnover.
dO yOU OffsEt GAIns And LOssEs WIthIn thE PORtfOLIO?
We have the ability to offset gains and losses in the portfolio. For most
clients our goal is to generate losses and take no gains while tracking
a pre-tax index. We strive to take no gains at all, short- or long-term
and to take short-term losses before they convert to long-term losses.
WILL yOU tAkE InstRUCtIOn On hARvEstInG LOssEs?
Our strategy works best when client preferences regarding timing of
tax losses can be incorporated into our trading, i.e. we seek instruction
on harvesting losses if possible.
WILL yOU tAkE In sInGLE stOCk POsItIOns And RUn A
Our strategy is specifically designed to take in single stock positions
and build a completion fund around low-basis concentrated positions.
dO yOUR PORtfOLIO ACCOUntInG systEms UsE fLExIbLE tAx-LOt
ACCOUntInG And dO tRAdERs hAvE OPtImIzAtIOn sOftWARE In
PLACE tO IdEntIfy thE mOst tAx EffICIEnt stRAtEGy?
Yes, we keep track of tax lots using our portfolio accounting system,
which is integrated with our portfolio optimization program. Trades are
initiated only after our traders use our after-tax optimization program
to evaluate a client’s portfolio (in which positions are identified by tax
lot.) Aperio measures pre-tax return dispersion by what it calls tracking
error, which is a measure of the portfolios pre-tax performance versus
the index. In addition to tracking dispersion, Aperio estimates the
dispersion for each portfolio depending on the portfolio size, number
of securities, and the nature of the index being tracked.
CAn yOU REPORt AftER tAx REtURns As WELL As PREtAx?
Aperio reports both pre-tax and after-tax returns for both the portfolio
and the benchmark.
WhAt AftER tAx bEnChmARk dO yOU UsE?
Aperio can track most major U.S. equity market indexes, including
the S&P 500, S&P 500/Barra Growth, S&P 500/Barra Value, S&P
MidCap 400, S&P MidCap 400/Barra Growth, S&P MidCap 400/
Barra Value, S&P SmallCap 600, S&P SmallCap 600/Barra Growth,
S&P SmallCap 600/Barra Value, S&P 1500, Russell 3000, Russell
1000, Russell 2000, Domini 400 Social, Carlisle Catholic U.S. Market
and Carlisle Catholic Small Cap indexes. Aperio can also design
customized benchmarks at the client’s request. All these indexes
can be customized to reflect after-tax returns to show the effects of
all taxable distributions adjusted for each client’s specific individual