New Zealand Portfolio Investment Entity (PIE) After-tax Performance Calculation Methodology. Morningstar Methodology Paper May 2011

Transcription

1 New Zealand Portfolio Investment Entity (PIE) After-tax Performance Calculation Methodology Morningstar Methodology Paper May 2011

2 Morningstar calculates the after-tax return for PIE funds as a simulation of the investment performance experienced by a notional tax-paying investor. Many factors not included in the simulation will affect an investor s actual in-hand return, including the timing of additional investment and divestment, any dollar-based fees, and the investor s tax rate. As such, the after-tax returns are best used for comparison and analytical rather than accounting purposes. Where appropriate, PIE after-tax returns are appended to the original, historical after-tax performance of the PIE fund s predecessor unit trusts and superannuation funds. To be eligible for inclusion in a PIE after-tax return simulation a fund must be unit pricing 1, and the fund company must provide Morningstar with sufficient data on the taxable income and tax credits on a per-share basis for each pricing day. The fund company must also provide details of any distributions paid by the fund to investors and any unit adjustments, such as splits and consolidations. Morningstar also requests that fund companies report any additional fees that are charged as a percentage of an investors account but are not taken into account in unit prices. Where possible, Morningstar removes this percentage from calculated returns. 1 Most performance that Morningstar reports is calculated from unit prices and distributions. However, several fund companies are unable to provide this information. In these limited cases, and in the interests of coverage and completeness, Morningstar accepts a monthly series of fund-company-calculated performance. Morningstar also accepts a monthly series of after-tax returns but only after verifying that the process of calculation used by the fund company is consistent with our methodology.

3 How is a fund s return normally calculated? Morningstar calculates the total return for a fund by simulating the experience of a notional investor with a single unit invested in a fund at the beginning of the period. This investor does not add to, or sell out from, their investment in the fund. The starting value (V 0 ) of their investment would obviously be their single unit multiplied by the Unit s Price 2 (P 0 ). V 0 = P 0 * U 0 The ending value (V 1 ) would be calculated the same way, the number of units multiplied by the price. V 1 = P 1 * U 1 The return (R 1 ) of the fund over the period would be the ending value divided by the starting value, minus one. R 1 = (V 1 / V 0 )-1 The price can change over time due to movements in the value of the underlying assets of the fund and any income that has been earned but has not been paid out. The number of units can also change. Any distributions paid by the fund to investors are assumed to be reinvested and Morningstar also accrues tax credits; adding to the units the notional investor holds. Morningstar uses an adjustment of the notional investor s units to estimate after-tax performance. What inputs are required? Fund companies must provide the requisite components which allow Morningstar to calculate the after-tax return. Morningstar requires the following per-unit values for each pricing day, covering the period since the previous pricing day. Taxable Income (TI) 3 Foreign Tax Credit (FTC) Dividend Withholding Payment (DWP) Resident Withholding Tax (RWT) Imputation Credits (IC) Morningstar s after-tax return simulation is calibrated to return no result whenever a fund is missing Taxable Income for more than 2 pricing days in a month. 2 Morningstar only uses exit prices in the performance calculation. More detail here: 3 A fund company can use available formation losses to shield income from taxation. Fund companies make this adjustment before supplying the taxable income figure used in the after-tax calculation.

4 What tax rate is being used? The headline Tax Rate (TR) used in the current after-tax return simulation is the highest applicable to PIE funds at the end of each pricing day. Historic changes to this tax rate have been taken into account in the simulation, and future changes will also be accounted for. The tax rate currently applicable is 28 percent. A tax rate of 30 percent was used for pricing days before 1 October 2010, and 33 percent before 1 April We also calculate all other PIR tax rates. How is the notional investor s tax account settled? Morningstar s simulation assumes the tax account is settled at the end of each pricing day. Settlement of a tax liability takes the form of a reduction in the number of an investor s units. A surplus of tax credits on a pricing day is settled by the creation of additional units. 4 Daily settlement is another deviation from the investor s actual experience (with the norm being either settlement on an annual basis or at divestment). Deviation from annual settlement has advantages in that it allows the geometric linking of returns, and makes day to day return calculations possible. Morningstar expects the impact of daily settlement on after-tax returns to be relatively small, and negative under normal circumstances. What is the specific calculation? Daily settlement takes the form of an adjustment to the number of units an investor holds in the fund. The amount of the settlement (SA) is estimated in the following manner. SA = ((TI * TR) (FTC + DWP + RWT + IC)) * U Or, Settlement amount = (tax liability) (tax credits) * number of units held The Unit Adjustment (UA) is calculated by the dividing the Settlement Amount by the end of day Unit Price (P). UA = -SA / P So, U 1 = U 0 + UA 4 An excess of tax credits will result in a refund. In reality, excess Foreign Tax Credits cannot be used in the calculation of the tax refund. However, we have included them in the calculation to keep the simulation as simple as possible.

5 1) Portfolio Turnover Rate: This measures the portfolio manager s trading activity by taking the lesser of purchases or sales (excluding all securities with maturities of less than one year) and dividing by average monthly net assets. A turnover ratio of 100% or more does not necessarily suggest that all securities in the portfolio have been traded. In practical terms, the resulting percentage loosely represents the percentage of the portfolio s holdings that have changed over the past year. The Calculation adopted as industry standard in Australia by the FSC is the same calculation as prescribed by the US SEC. All funds except money market funds are able to provide this data calculation. Formula Portfolio Turnover Rate = Lesser of P or S, divided by Ave Net Assets P = Absolute value of all Purchases for portfolio (e.g., all securities bought by the PM). S = Absolute value of all Sales from portfolio. Ave Net Assets = Totaling the values of the portfolio securities as of the beginning and the end of the first month of the fiscal year in question and as of the end of the succeeding 11 months, and dividing by 13. Flows are not accounted for. Formula Notes: Exclude: -From both Numerator and Denominator all Short Term Cash Positions and Options whose Maturity or Expiration dates are one year or less. -From both Numerator and Denominator all Purchases or Sales of another separate account/fund in exchange for units*. Include: -In both Numerator and Denominator all Long Term Securities, including Government Bonds. -In both Purchases and Sales all short sales the registrant intends to maintain for more than one year**. -In both Purchases and Sales all Put and Call Options where the expiry date is longer than one year form the date of purchase***. -In both Purchases all cash paid upon conversion form one security to another. -In Purchases the cost of Rights or Warrants purchased. -In Sales the net proceeds of Sales of Rights or Warrants. -In Sales the net proceeds of portfolio securities which have been called, or for which payment has been made through redemption or maturity. *If during the fiscal year the registrant acquired assets from another fund, this would be excluded from the purchases. If it sold the assets it would be excluded from the sales. Any adjustment should also be made to the Average Net Assets where appropriate. Please make note when this occurs. **Proceeds of short sale should be included in Sales, proceeds of covering a short sale should in in the Purchases. ***Premiums paid to purchase options should be included in Purchases and premiums received should be included in the Sales.

6 KiwiSaver (Periodic Disclosure) Regulations 2012 Morningstar Submission Clause Number Clause 6 Clause heading Meaning of publicly available Clause 18 Performance and returns example Clause 23 Information about fund fees and costs Clause 30 Information about asset allocation and portfolio holdings Clause 31 Portfolio Turnover Clause 32 Additional information about assets that must be included in annual disclosure statement Submission We believe it is important that an extractable version of this is made available online with the data points contained in this document. For both comparative purposes and academic research prospectors data aggregation is vital. When we interact with our global data analyst teams, they tell us, data in extractable formats will reduce data errors immeasurably because technology involved now can eliminate manual human intervention if the data is provided in.csv,.xml,.txt or.xls format in a consistent manner. Fund managers can do this easily and with minimal cost. There should be a mandated calculation to which the after tax return is generated. We have worked with the industry to develop a methodology. Please see attached. We have also collated and reported the first after tax return survey, seen here: This should be worded to ensure that all asset based fees deducted from member balances are also included. We believe in full disclosure, but at the margin, the granularity of fees could be too much. If a scheme charges a 1% flat fee to its members, why does it need to proportion it out? It s more important that all fees are included in a TER, what the costs are for legal and marketing are less important. Define geographical location: country where listed on an exchange or country where the business is. It should be the former. We also believe fund managers should split out Australasian Fixed Income. The risk return profile for a NZ investor in NZ v AUS Bonds is different. Most contemporary asset allocation models treat any nondomestic domiciled fixed income as international. We believe that both the definition mandated by the SEC and suggested by the FSC in Australia should be adopted here. It works on the assumption that all turnover is turnover, and whether forced or not this is a cost borne on the investors in the fund. Especially as all KiwiSaver funds on our database don t have buy/sell spreads, its especially relevant. This calculation should put the investor first above all else. Whether it is forced turnover or not it is a still a feature of the fund which remains to the investor and or potential investor. Methodology is attached. There is confusion about the level of assets that should be listed. Morningstar believes this should be strictly defined to avoid confusion and poor interpretation. Some fund managers want to do look through portfolios, some list their funds only in multi-sector funds. We believe it should be defined as the custodian valuations list of assets.

7 This will cause it to list assets directly owned by the fund. If it owns funds, then list funds. Morningstar prefers full portfolio holdings disclosure, however if a holdings is over 5% and is a managed fund, then the holding must be available on a web link. Again this should be also available in an extractable format, to ensure data aggregators can access with minimum risk of data errors. Morningstar would be happy to discuss this further as it is a comlex issue. For example, fund managers should be required to use a public identifiers. ISIN/SEDOL/CUSIP/Ticker. There is usually more than one line of stock, simply stating BHP is insufficient level of detail for some investors, there are actually 6 different listings for BHP and 31 sub listings. They will all likely have different risk/return and liquidity characteristics so identifying the asset is important. Morningstar also strongly believes that fund managers must provide full portfolio holdings at least twice a year. Best practice globally is four times a year with a 2-month lag. Having full portfolio holdings reported twice a year with a three month lag will avoid any problems around a fund managers intellectual property. This is critical to allow for more informed research and monitoring, but also for academia to study and assess KiwiSaver providers and help to further engage with the industry on key topics and aid future research and regulation. Full holdings disclosure has led to a huge amount of academic research in other countries which has further enriched the industry and most importantly the individual investor experience. Clause 34 Liquidity and debt ratio Liquidity Ratio is Subjective to the fund manager, who will essentially nominate the proportion of stock they believe they can liquidate in 5 days. Subjective elements should be removed, and just have the proportion not listed on public exchanges. Clause 37 Information about key personnel There is some confusion we sense regarding the five people who most impact returns definition. This could be anything from the lead manager, to underlying sector manager through to product people. We believe is should be simplified to include anyone up to five people in order of importance who have discretionary decision making powers or influence to impact the assets owned by the fund itself. This removes the single sector managers of a multi sector fund who are the most important people of that fund etc. From a multi Sector managers point of view, research has shown 90% of the return of the fund is driven by Asset Allocation, so the people who impact this function should be deemed the most important.