Why tax-smart portfolio design is the new advantage for advisors

Strong investment returns matter, but what clients ultimately keep is what truly counts. That’s why forward-thinking advisors are increasingly incorporating tax-aware portfolio construction into every investment decision. Doing so can make a huge difference to clients’ bottom lines while differentiating an advisor’s practice.

“The advisors gaining the greatest competitive advantage aren’t necessarily taking more investment risk or making dramatically different portfolio decisions. They’re thinking more holistically about how portfolios are built, with after-tax outcomes becoming part of the conversation,” says Pawan Vatvani, head of portfolio construction with 2ND ENGINE at PICTON Investments.

Having worked with hundreds of advisors, Mr. Vatvani has seen this evolution firsthand. Across the industry, this shift is becoming increasingly important. A recent Cerulli Associates report found that 76 per cent of wealth managers now view tax management as a central focus of portfolio construction. That reflects the growing recognition that tax optimization can improve client outcomes meaningfully.

Advisors are now expected to do more than build diversified portfolios. Clients increasingly want guidance that considers every aspect of their financial lives, including taxes.

“Many advisors already understand the importance of taxes. The opportunity is moving from simply being tax aware to incorporating tax-smart principles throughout the portfolio construction process,” Mr. Vatvani says. “It’s not about changing what clients own. It’s about being more intentional about how portfolios are designed.”

Look beyond investment returns

For many Canadian investors, taxes can be the single largest cost they face, Mr. Vatvani says, consuming more wealth than advisory fees, fund expenses and transaction costs combined.

One useful way to evaluate portfolios is through the tax efficiency ratio. For example, if a portfolio generates an 8 per cent annualized pre-tax return but only 5.5 per cent after taxes, its tax efficiency ratio is approximately 70 per cent. That means almost one-third of investment returns are leaking out through taxes.

“Every dollar lost to unnecessary taxation is a dollar that no longer compounds for the client,” Mr. Vatvani says.

Although no portfolio will achieve perfect tax efficiency, thoughtful portfolio construction can improve outcomes meaningfully over time. Through PICTON Investments’ 2ND ENGINE optimization platform, advisors can evaluate how investment location, account structure and portfolio design work together to improve after-tax efficiency.

Lessons for stronger outcomes

Based on his extensive reviews of advisor portfolios, Mr. Vatvani sees several common characteristics among practices that deliver stronger after-tax outcomes consistently.

Start with the client’s after-tax objective. Investment success should ultimately be measured by helping clients retain more of what they earn, not simply by how much their portfolios have grown.

Next, make taxes part of every portfolio decision. Rather than treating taxes as a year-end exercise, integrate them into portfolio construction from the beginning.

Widening the lens is also key, Mr. Vatvani says. Portfolio construction has traditionally been managed against three dimensions: risk, alpha and fees. He says PICTON Investments adds a fourth: tax.

Managing tax as its own “budget,” rather than letting it erode returns quietly, gives advisors a clearer view of where it’s costing clients and where they can act.

Look beyond asset location, too. Many advisors already understand the importance of placing tax-efficient investments in the appropriate registered and non-registered accounts.

But effective tax-aware portfolio construction extends further, Mr. Vatvani says, to factors such as account type, investment structure, portfolio sleeve, tax characteristics and whether portfolio turnover creates unnecessary taxable events. Considering these together can optimize outcomes.

The role of alternatives

Another main lesson is to explore strategies and investments that improve tax efficiency. Alternative investments may help to reduce tax drag while supporting long-term portfolio goals. Mr. Vatvani points to long-short equity strategies.

“The primary objective aims to deliver returns comparable to market benchmarks, but there are also underappreciated tax efficiency benefits to the portfolio,” he says.

Mr. Vatvani points out additional opportunities for tax-loss harvesting. Because portfolio managers maintain both long and short positions, they often have greater flexibility to realize losses that can offset taxable gains while continuing to pursue investment opportunities.

“A long-short strategy simply provides more tax-management tools,” Mr. Vatvani says. “That flexibility has the potential to enhance net investment outcomes over time.”

Adding value

As investor expectations continue to evolve, tax-aware portfolio construction is becoming even more critical and can help advisors to stand out.

To Mr. Vatvani, the advisors embracing these principles aren’t simply improving portfolios. They’re also strengthening client relationships, demonstrating a more comprehensive planning approach and delivering additional value.

“It’s about looking at taxation across every layer of the portfolio rather than making isolated decisions,” he says. “Every portfolio decision has a tax consequence. The more intentionally advisors account for that, the greater the opportunity to improve client outcomes.”

Learn more about how to support investor returns at PICTON’s tax-smart investing advisor resources hub.

Advertising feature produced by Globe Content Studio with PICTON Investments. The Globe’s editorial department was not involved.