Is Your Alpha Big Enough to Cover Its Taxes? A Quarter-Century Retrospective

• DOI: 10.3905/jpm.2018.44.5.078
• Publication Date: 2018-04-30T15:00:47Z
• Authors: Rob Arnott; Vitali Kalesnik; Trevor Schuesler
• Keywords: 0502 economics and business; 05 social sciences

This article revisits the findings (published in this journal) of Jeffrey and Arnott, who reported that over 95% of active managers underperformed a capitalization-weighted index fund on an after-tax basis. The authors posit that much has changed in the quarter century since the publishing of that article, including increased tax awareness on the part of investors and advancements in the tax efficiency of some investment funds and vehicles; thus, investors may now have a better opportunity to generate alpha that is big enough to cover its taxes. The authors measure the degree to which fund characteristics affect a fund’s tax burden and compare the tax efficiency of investing in exchange-traded funds and mutual funds. The authors calculate the after-tax returns of funds and examine whether new categories of funds (e.g., smart beta) are better at generating after-tax alpha than their active and passive fund peers.