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Taxes – Another Killer of Attorney Returns

Investors can't eat before-fee, pre-tax returns, however, investment managers can, and do, and that's the problem.

plate with amuse-bouche

After-fee, after-tax returns are often smaller than investors realize.

Due to the structure of K-1 income, taxes are a killer of attorney returns.  For attorneys, the only criteria for investment performance that matters is after-fee, after-tax returns.  This is because the vast majority of their investable assets are likely to be in taxable accounts.[1]

While investors are frequently presented eye-popping gross returns, they are like top-line revenue numbers for startups.  What falls to the bottom line is often not impressive.

As I’ve discussed in a previous post, the negative compounding effects of fees can eat up 20 to 30 percent of terminal values over long time horizons.  The same is true of taxes.

This is why investors need to be laser-focused on fees and after-tax returns.

The Goldman Sachs Capital Growth Fund – A Strong Candidate… for Euthanasia

The Goldman Sachs Capital Growth Fund (GSPIX) cannot justify its existence.  It is an institutional growth fund, meaning it has the lowest fees of all the share classes offered and has a $1M minimum investment.

Despite this, the fund has underperformed its benchmark index returns by 12.5 percent, 16 percent, and 7.1 percent, on a 1-, 3-, and 5-year basis, respectively.[2]  However, the real damage comes when the fund is viewed on an after-tax basis.

On an after-tax basis, the fund is a wealth confiscator working for the IRS.

A Killer of Attorney Returns: GSPIX[3]

attorney returns 1

Taxes knocked down the performance by 11.3, 19.6, and 14.4 percent, on a 1-, 5-, and 10-year basis, respectively.

It gets worse, the fund is a closet indexer.

GSPIX Active Share

According to the Goldman Sachs, the GSPIX Fund has an active share of 45, meaning that 55 percent of the fund is identical to the benchmark Russell 1000 Growth Index.[4]

Thus investors are paying an active management fee of 75 basis points for the entire portfolio, when only 45 percent of it is actively managed.  (The benchmark index ETF, IWF, has a 20 basis point expense ratio.[5])

In the chart below, the extent of the closet indexing is obvious in the sector allocations.  (While it is possible to have similar sector allocations to a benchmark and have high active share, primarily by concentrating in a few names within each sector, that is not the case here.)

GSPIX v. Benchmark Sector Allocation[6]

gspix sector allocation

By owning this fund, its investors are paying Goldman Sachs to be a closet indexer, to underperform, and to generate taxes for them.

This is a spectacularly bad trade.

I will assume these facts are not being explained to investors (certainly not the taxable ones) because the fund has $949M in assets under management.[7]

There is no excuse for investing taxable accounts in funds with poor or mediocre performance, low active share, and high tax-inefficiency.  Index ETFs don’t distribute capital gains, or if they do, they are de minimis.  For instance, the iShares Russell 1000 Growth ETF (IWF) has distributed zero capital gains over the past five years.[8]

Conclusion

Most investors would be shocked to see how poorly their investments perform on an after-fee, after-tax basis.  However, in my experience, when they get investment reports from their advisors, they are almost always on a pre-tax basis.

Unfortunately, investors can’t eat pre-tax returns, however, investment managers can, and do, and that’s the problem.

Bantam offers due diligence services that look for abuses like high-fee, high-tax inefficient funds on a stand-alone or ongoing basis.  Importantly, our clients don’t have to move their assets to work with us.  You can read about our due diligence services here.

We also offer completely personalized, professionally designed and bound Family Strategy Books, which go miles beyond what is commonly referred to as “financial planning”.

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Notes:

[1]       In my experience, it is very rare to see a $10M IRA account and a $100M IRA is unheard of.  No so for individual accounts.

[2]       Source: Bloomberg.

[3]       Goldman Sachs Capital Growth Fund webpage;  Available at: https://www.gsam.com/content/gsam/us/en/advisors/fund-center/fund-finder/gs-capital-growth-fund.html#activeTab=performance;  Accessed June 4, 2018.

[4]       Goldman Sachs Active Share Report; Available at: https://www.gsam.com/content/dam/gsam/pdfs/us/en/fund-resources/other-reporting/Active_Share_Report_Fundamental%20Equity%2015%20Day%20Funds.pdf?sa=n&rd=n; Accessed June 4, 2018.

[5]        Source: Bloomberg.

[6]       GSPIX Summary Prospectus; Dated April 18, 2018; Available at: https://www.gsam.com/bin/gsam/servlets/LiteratureViewerServlet?pdflink=%2Fcontent%2Fdam%2Fgsam%2Fpdfs%2Fus%2Fen%2Fprospectus-and-regulatory%2Fsemi-annual-report%2Ffundamental-equity-growth-funds-sar.pdf&RequestURI=/content/gsam/us/en/advisors&sa=n; Accessed June 4, 2018.

[7]       GSPIX website; Available at: https://www.gsam.com/content/gsam/us/en/advisors/fund-center/fund-finder/gs-capital-growth-fund.html#activeTab=overview; Accessed June 4, 2018.

[8]       Source: Bloomberg.

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