Measuring Tax Alpha

Wealth managers can use the concept known as tax alpha in conjunction with their existing performance-attribution framework to explain a client’s after-tax performance. Often the framework requires their making several assumptions with no clear guidance about how to specify them.

We propose two frameworks for the calculation of tax alpha — a shadow benchmark and an event-based approach — to provide transparency around an after-tax attribution calculation. The main difference between them is the choice of the reference portfolio. The approaches also differ in how they model client-directed actions, dividend payments and benchmark rebalancing. We further develop two versions of the shadow-benchmark approach. The following exhibit compares the approaches.

Comparing how well the approaches meet the reference-portfolio assumptions