The composite: It’s the tool investors and their advisors most often reach for when evaluating asset managers.
Age of accounts
Over time, especially in rising markets, it becomes relatively more difficult to find losses in a portfolio. This is caused by the underlying securities appreciating in value and by a reduction in the portfolio’s cost basis due to loss-harvesting activities, and it’s apparent when you compare the relative tax alpha of older and younger portfolios held in the same composite. (Tax alpha is a metric that helps distill the value of tax management by isolating the additional return derived exclusively from tactics such as tax-loss harvesting and gain deferral.)
For example, the increased market volatility we saw in December 2018 provided ample opportunities to harvest losses across many portfolios, regardless of their age. But younger accounts—those with less overall appreciation from the long bull market of the past decade—will naturally have more losses to harvest than older accounts.
A composite that contains a larger percentage of newly funded accounts will thus appear to have higher after-tax returns than those of composites with a greater number of aged accounts. That’s why, when evaluating the after-tax composite returns of different managers, investors must consider that the relative age of the accounts may skew the results and make for a biased comparison.
When preparing a composite, a manager has some flexibility to determine which accounts to include. As a result, it’s important to closely examine a manager’s construction methodology to consider whether the composite includes:
The bottom line