Improving Returns by Wrestling the Tax Alligator
Sunday, June 18, 2006
Eaton Vance Corp.'s Duncan Richardson is generating some of the best investment returns in U.S. mutual fund industry, and his shareholders are paying about half as much in taxes.
The Eaton Vance Tax-Managed Equity Asset Allocation Fund rose 11 percent in the past 12 months, double the average of competing funds that hold a mix of large-company "growth" and "value" stocks, data compiled by Chicago-based Morningstar Inc. show. Shareholders' taxes equaled 0.41 percent of assets in the year ended March 31, less than half the industry average.
Richardson seeks to minimize taxes by investing his $537 million in seven Eaton Vance funds that limit trading and sell money-losing stocks early. The strategy reduces gains that result in higher taxes for investors.
"People ask us why we allow the tax tail to wag the dog," Richardson, 48, said in an interview from his office at Boston-based Eaton Vance, where he's chief investment officer of the equities group. "The tax tail is pretty big. It's more like the tail of an alligator."
While investors typically focus on operating expenses and fees when comparing funds, taxes put a bigger drag on returns, he said. U.S. mutual fund investors paid $15.2 billion in taxes last year, including those from distributions, dividends and profits, according to Lipper Inc., an industry research firm owned by London-based Reuters Group PLC.
This year's tax bill may be bigger because the Fidelity Magellan Fund last month said it plans to distribute $10 billion in capital gains to shareholders, incurring government charges of about $1.5 billion at the 15 percent long-term rate. Magellan manager Harry Lange has overhauled the fund's shareholdings since he replaced Robert Stansky last year.
Eaton Vance's fund, opened in 2002, climbed at an annual rate of 12 percent in the past three years, beating 90 percent of competitors that invest in fast-growing and undervalued companies, Morningstar reported. The fund has a four-star rating from Morningstar, the firm's second highest, and has a Sharpe ratio of 1.26, compared with 1.13 for all U.S. large "blend" funds. The greater a fund's Sharpe ratio, the better its risk-adjusted performance.
Fidelity's Tax-Managed Stock Fund, which also invests in a blend of large-company stocks, advanced 5.2 percent during the past year and an annual average of 12 percent over three years, according to Morningstar.
Richardson was hired by Eaton Vance in 1987 as an analyst and started running tax-managed funds three years later. A 1979 graduate of the U.S. Naval Academy in Annapolis, he spent five years on submarine duty before getting a master's degree from Harvard Business School.
Eaton Vance, founded in 1924, originally billed itself as a conservative manager of wealthy individuals' money. Eaton Vance today is the largest U.S. manager of funds designed to keep taxes at a minimum, with total assets of about $119 billion.
The firm's Tax-Managed Equity Asset Allocation Fund has about 23.5 percent of its money in the Tax-Managed Growth Fund, also managed by Richardson; 22.5 percent in Tax-Managed Value, run by Michael Mach; 17.5 percent in Tax-Managed International, overseen by Edward Allen and Thomas Hunt; and 14 percent in Multi-Cap Opportunity, managed by Arieh Coll. The remainder is invested in funds that hold stocks of small and mid-sized companies.
With all its fund holdings, the allocation fund had stakes in 931 companies as of March 31, helping shield investors from large declines in individual shares.