A Strategy to Maximize
Don Peters, portfolio manager of the T. Rowe Price Tax-Efficient Equity Fund, discusses his strategies to minimize capital gains and maximize after-tax returns.
on Peters became interested in tax-efficient investing around the time he joined T. Rowe Price in 1993, a few years after obtaining an M.B.A. in finance from the University of Pennsylvania's Wharton School of Business. "I read Is Your Alpha Big Enough to Cover Its Taxes?, an influential article by Tad Jeffrey and Rob Arnott, and had this ‘wow' moment," he says. "I realized the huge impact that taxes can have on an investment portfolio over time." This focus on taxes has stayed with him throughout his 20-year career at T. Rowe Price, where he has managed the Tax-Efficient Equity Fund since its inception in December 2000.
Peters notes that many investors overlook the potential for taxes to impact the long-term performance of their taxable investment portfolios. Studies have shown that taxable portfolios can lose an average of one to two percentage points per year between pretax and after-tax returns. "While this may not seem like much in any single year," he notes, "it can have a big impact over longer periods of time."
THE IMPORTANCE OF ASSET LOCATION
Investors with access to both tax-deferred and taxable investment accounts first need to decide where to hold specific assets. Investments with high interest income, high dividend production, or high turnover—each of which could have important tax consequences for individual investors—may be more appropriate for a tax-deferred investment account. Investments already managed with an eye toward tax efficiency, including low-turnover portfolios such as the T. Rowe Price Tax-Efficient Equity Fund that are oriented toward long-term growth, might be more appropriate for a taxable investment account.
A COMPREHENSIVE STRATEGY
"Our focus is not purely on tax mitigation," Peters says. "Instead, we look to minimize capital gains and maximize after-tax returns." The T. Rowe Price Tax-Efficient Equity Fund focuses on the long term by investing in a broad range of high-quality mid- and large-cap stocks in companies with sustainable competitive advantages, strong market positions, and reasonable valuations. Peters likes to let his winners run and tries to avoid selling a stock—and realizing capital gains—unless a company's long-term outlook has deteriorated significantly.
CONSISTENT, LONG-TERM FOCUS
Peters also believes that market timing is virtually impossible. "Selling at the top and buying at the bottom requires the right timing decision not once but twice, making the odds of success very poor," he says. A long-term approach helps Peters see through short-term trends to find buying opportunities that others may have missed. Although he makes new purchases as opportunities arise, he does not trade opportunistically. This buy-and-hold strategy requires patience and relies on the deep industry and company knowledge provided by T. Rowe Price's global research platform.
The T. Rowe Price Tax-Efficient Equity Fund's investment philosophy remains consistent regardless of prevailing market conditions, a steady approach that can add value over longer time periods. While tax-efficient investing may not be appropriate for every investor in every situation, it could be appropriate for long-term investors who understand the impact that taxes can have on their portfolios.
Fund holdings are subject to market risk, and share prices may be more volatile than those of a fund focusing on slower-growing or cyclical companies.