Tax losses distort fund performance

Over the past three years as international equity markets have fallen managers have built up tax credits. These tax credits, which in some case are quite substantial, can be used when the market starts rising.

Now that markets have had their first substantial quarterly returns for some time managers are starting to use these credits.

Morningstar chief executive Scott Cooley, who is currently visiting New Zealand, says the deferred tax issue is a major one and it’s made tricky because managers are taking differing approaches to it. Also the effect on an actively managed fund, which provides for tax, is different to that of a passive fund.

“I’m a free market guy,” he says. “But I think there’s a need for clear guidance on this (issue).”

He says because managers take different approaches to handling tax losses, return figures become less meaningful.

Cooley, who has recently moved Down Under from the United States, would like to see this area (and some others relating to tax) cleared up.

He says that in the US managers have a use it or lose it policy on tax losses. If the losses aren’t used within eight years then they lose them.

Morningstar New Zealand boss Ross Weavers agrees it is a “major issue” and he would like to see greater disclosure from managers.

While it is a significant issue, Cooley points out that it only relates to international share and multi-sector funds as they are the ones that have made losses recently.

Cooley says that fund manager ratings have been impacted by the fact that managers have different policies on how to treat tax losses.

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