1. March 2006 Post Tax Investment Management (a practitioner’s perspective) Presented by Geoffrey Brianton – Director Quantitative Advisers

2. Tax Aware Investing 2 Shortfalls in Contemporary Practice Pre-Tax Return Franking Credits Earned Tax Net Return Fund Managers are largely assessed on this Investors actually care about this Usually regarded as an outcome of the process For illustrative purposes only. Tax circumstances may differ. Diagram is not to scale

3. Tax Aware Investing 3 Reasons for Discrepancy Between Practice and Objective Prevalence of Pre-tax Surveys Widespread use of Pre-tax benchmarks Difficult to incorporate tax effects into trading decisions Portfolio settings will differ despite a common outlook for stocks Expensive / lack of consensus to calculate accurate post-tax benchmarks

4. Tax Aware Investing 4 Overview Value of deferring Capital Gains Tax Value of realising gains after 12 month Value of Franking Credits Roughly – what is it worth? Does the marginal tax rate matter? Can it be measured?

5. Tax Aware Investing 5 Value of Deferral of Capital Gain (I) Consider the following equity investment $100,000 (Net) $110,000 (Gross) Portfolio has a beta of 1.1 Value of deferred CGT is the effect of the increased Beta ….. but this assumes the investor does not respond to any accrual of CGT liabilities

6. Tax Aware Investing 6 Value of Deferral of Capital Gain (II) Consider the following portfolio –$100,000 Equity (Net) $110,000 (Gross) –$120,000 Cash Portfolio has a beta of 0.5 As CGT increases the investor could increase the cash holding Value of unrealised CGT can be measured by the value of the implicit interest free loan

7. Tax Aware Investing 7 Simulated Unrealised Gains (using All-Ords 1936-2005)

8. Tax Aware Investing 8 Long Term Average Unrealised Capital Gain

9. Tax Aware Investing 9 Effect of Turnover on Capital Gain (I)

10. Tax Aware Investing 10 Effect of Turnover on Capital Gain (II)

11. Tax Aware Investing 11 Franking Credits Tax Credits to offset tax already paid by companies when the net proceeds are passed to investors in the form of dividends Cash Dividend Franking Credits Prima Facie Income Tax Net Return Franking Credits Cash Dividend Prima Facie Income Tax For illustrative purposes only. Tax circumstances may differ. Diagram is not to scale

12. Tax Aware Investing 12 The Value of Franking Credit (I) – Not Priced Into the Asset

13. Tax Aware Investing 13 The Value of Franking Credit (II) – Fully Priced into the Asset

14. Tax Aware Investing 14 The price of franking credits (III) – Off Market Buy Backs

15. Tax Aware Investing 15 The Value of Franking Credits (IV) - Hybrids At maturity: greater of $102.56 or 8.34 TOL shares ‘Option-Adjusted’ Spread1.40% Spread including franking credits4.38% Franking credits are valued at 10% to 20% of face value

16. Tax Aware Investing 16 The Value of Franking Credits (V) – Converting Pref. Share

17. Tax Aware Investing 17 Summary of Tax Cost and Benefits

18. Tax Aware Investing 18 Three Steps towards a Post-Tax Benchmark Deferral of Capital Gain –Value lost/gained interest free loan (using simple index fund as proxy) -Expressed as an annuity? Realisation of gains under 12 months –Treat increased tax liability as loss of alpha -what about cash flows? Tax Credits –Include tax credits as part of both the benchmark and the portfolio’s return

19. Tax Aware Investing 19 Wrap - Up Contemporary Practice falls short in tax management Benefits of tax awareness are significant Costs for ignoring tax implication of trades can be high The lower an investor's margin rate the more tax aware investing can be a source of Alpha Higher marginal rates require higher Alpha to overcome the negative tax effects. A perfect post-tax benchmark is (probably) too expensive but reasonable approximations can be made.