Alternative strategies are more dynamic and change their risk exposures as a function of market conditions more frequently than a passive strategy. We set out to build the first suite of risk managed ETFs that employ a systematic approach to dynamic asset allocation in a cost efficient and transparent manner. Our risk management overlay is designed to protect investor capital during prolonged drawdowns by shifting to cash and fixed income during turbulent market conditions. There are a number of key advantages that ETFs have over other product types such as mutual funds, separately managed accounts, and hedge funds when employing an active management approach. Using an ETF wrapper provides greater value than other alternatives because they are more transparent, provide intraday liquidity, and help investors keep more of what they earn by avoiding unnecessary tax implications.
Keep More of What You Earn With ETFs
You can’t look at pre-tax returns when comparing the performance between different investment vehicles because they each have unique tax consequences. ETFs, and only ETFs, benefit from a unique structural difference that makes them highly tax-efficient – the custom redemption process. As a result, ETFs have the ability to transfer shares in-kind via custom redemptions rather than sell on the open market which reduces or even eliminates the distribution of capital gains to investors. In contrast, mutual funds, separately managed accounts and hedge funds must typically buy and sell securities on the open market which triggers realized taxable gains. Even if the same investment strategy is employed in each of the difference vehicles, it will lead to very different after-tax returns.
As you can see in the example below, the lower taxation inherent to ETFs means that you need to earn a much higher pre-tax return in other investment vehicles to be equivalent to the ETF after-tax.
The example above is hypothetical and models a 10% gross annual rate of return for each type of taxable investment. The fees are examples based on a sampling of similar fund types. This is a capital appreciation example and doesn’t factor any potential dividends that any fund type may pay out during the year. Taxes are modeled based on the assumption that all strategies examples are tactical in nature and result in 100% short-term capital gains of which 50% of those gains distributable depending on investment type. The ETF investor who passively allocates to a portfolio of ETFs and doesn’t sell any of the ETFs will not trigger a taxable event as there was no ETF sale during the year. The hedge fund investor will receive a K-1 reporting their profits which will result in a tax liability when filing their return. The alternative mutual fund and separate account investor will receive a 1099 reporting the gain which will result in a tax liability when filing their return. Calculations: Return After Fees = Gross Return – Management Fee x (1-Performance Fee). Taxes = Distributed Gain x 45% Tax Rate. Net Investor Return = Return After Fees – Taxes. Nothing herein shall be considered tax or legal advice. Please contact your professional tax advisors for more detailed tax advice on investments.