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RFRM may favour absolute return funds

Tower Managed Funds cautiously supports plans for RFRM, but says it should be introduced across the board.

Thursday, March 21st 2002, 8:32AM

by Rob Hosking

Tower Managed Funds has cautiously endorsed the McLeod tax review’s suggestion for changes to the taxation of investments – but with one big reservation.

The McLeod panel recommended that initially the risk free rate of return method (RFRM) only be applied to offshore investments.

However, Tower suggests the government would be unwise not to apply the same locally.

“If you only bring the risk free rate of return method in for offshore investments, you potentially create a huge distortion,” general manager investments Richard Baker says.

He says RFRM has considerable advantages. From the government's point of view, it gets the tax regardless of the performance of the market: “The government no longer shares in the risk of the equity market”, is how Baker puts it.

The investor has some certainty – the amount of tax due that year is known at the outset.

“It also removes the tax issue when investors are deciding what investments to make, which from an objective point of view is excellent. Investors need to focus on the important stuff, like the performance of the investment and the performance of the manager. That’s got to be a good thing.” he says.

And if it is adopted, fund managers can be expected to incorporate the tax within their offerings.

“In a bad year, they sell the requisite number of units to meet the tax liability. That’s a product design issue which I don’t see as being fatal to the risk free rate of return model at all.”

The proposal, which is still only under consideration, is also likely to further drive investments into absolute return funds, he says.

Currently, the risk free rate of return – calculated by the going rate for government stock, and adjusted for inflation and the individual investor’s tax bracket – is about 4%.

If an investor knows at the start of a tax year that they have an absolute tax liability, they should look at absolute return funds.

“Anything over (the risk free rate of return) is tax free. Therefore as a rational investor, I should be looking for an absolute return fund – one which aggressively looks at being positive, given a certain degree of risk.”

Baker says the need for better guaranteed returns, in order to meet that tax liability, is likely to contribute further to the rush towards the more conservative hedge funds which has been a feature of the post-dot.com bust markets. It is this area where Tower has pitched its Advantage Investment Series, which it offers in tandem with Deutsche Asset Management.

For New Zealand, if the tax method were only applied to offshore investments, it could make those investments even more attractive.

This is likely to add to the distortionary effect – more New Zealand funds would be heading offshore at the same time as the government’s superannuation fund – also likely to primarily invest offshore – gets under way.

Rob Hosking is a Wellington-based freelance writer specialising in political, economic and IT related issues.

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