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Why Transitioning from Active to Passive Doesn’t Have to Be Taxing

February 3, 2021
Suppose a separately managed account (SMA) has had the same active manager for a number of years. The market has done well, and the manager has kept pace or maybe even outperformed. However, recent performance has lagged, or there’s been a change in management or investment philosophy—or, for whatever reason, expectations have dropped for the manager’s ability to achieve their alpha target. One option is to stay with the manager, since the benefits of transition might not outweigh the tax hit. Another choice would be to liquidate the holdings and move to an index-based, lower-fee exchange-traded fund (ETF). The problem is that the tax cost resulting from the liquidation is typically too hard to swallow.

Luckily there’s a third option between these two: a tax-managed SMA. This paper will explain how this option offers a lower upfront tax cost compared with liquidating, provides ongoing opportunities for tax-loss harvesting, and brings the portfolio’s returns closer to the market.

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Andrew Subkoviak, CFA

Senior Investment Strategist

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Michael Kincheloe, CFA

Senior Quantitative Analyst

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