Tax-Smart Portfolio Valuation and Performance Measurement

The Journal of Portfolio Management, August 2021

The reported performance of a portfolio is consequential for both investors and managers. One component of the return calculation is the beginning and ending value of the portfolio. The standard in the industry is to calculate portfolio values from the market prices of the constituent securities. Assuming that the portfolio can be liquidated at these prices, in the absence of tax considerations the market value accurately represents the true value of the portfolio, and therefore the resulting measure of performance is uncontroversial.

But what if the portfolio is taxable? Neither the market value nor the liquidation value accurately represents the true worth of a taxable portfolio. However, accurate values are essential to calculating the performance of mutual funds and ETFs. This is especially true for tax-exempt muni portfolios — interest is tax-free, but capital gains are taxable. We will explore three alternatives to pretax value: liquidation value, hold value, and the larger of these two, defined as tax-smart value. We recommend the tax-smart value to measure the performance of an actively managed portfolio.

Get the article text here:

Research Category: