Managed funds performance tables tell a story, but it's a partial story. There's a lot they leave out.
And to be fair managed funds are complicated beasts. Take for example your typical Australian equities managed funds table: There will be columns of returns over one year, three years, five years and longer - and the returns will usually be after fees but not after tax.
Tax is an issue with all investments, but particularly with Australian equities, which have imputation credits included in their distributions.
Some funds actively target imputation credits and their managers are willing to give up potential but uncertain returns from capital gains in favour of the higher certainty associated with dividends and franking credits. These are particularly valuable in low tax environments such as superannuation or allocated pensions.
If imputation credits are not included in returns (and separately) it is hard to provide a comparison of total pre-tax returns. The ranking of product returns in the table could change dramatically.
Then there are capital gains. These are taxed when they are realised, meaning that in a distribution year the total realised gains are greater than realised losses (which includes any accumulated losses).
A high turnover strategy (in which individual shares are held for shorter amounts of time) will have a higher tax liability more than a low turnover strategy, since capital gain taxes are discounted when held for more than 12 months. But this discount has more of an effect on after tax returns the higher the tax rate.
For a person holding their investments in an allocated pension there is no benefit to a low turnover strategy. They pay zero tax on realised capital gains, which means the discount means nothing to them.
This brings us to the concept of embedded capital gains and losses. Embedded gains may be realised and awaiting distribution, or they may be unrealised, in which case they are realised when the underlying securities are sold for higher than their purchase price. In either case an investor buying into a fund with embedded gains might also be buying into a potential tax liability in a situation where they haven't enjoyed the benefits. It's complicated, but getting a tax bill on gains you haven't enjoyed is, well, not enjoyable.
On the plus side (for new investors) there may be embedded capital losses. This occurs when securities are sold for less than their purchase price (a realised loss) or they have gone down in price from their purchase price.
Embedded losses hang around until the fund is wound up or they are netted out against gains. The important thing is that they can be of great benefit to new investors, particularly those on the highest rates of tax. Why? Because future realised gains must be netted against the losses before capital gains tax must be paid. This means there won't be any distributed capital gains until all the net losses are used up.
This helps in two ways. First, deferring tax has its own monetary benefit. Secondly, the investment may be realised in a future lower tax environment.
Finding funds with embedded losses is a bit of an art form. They are usually funds that were successful in terms of asset gathering but then suffered from net cash outflows brought on by underperformance during a market downturn.
This means that assets bought high were forcibly sold (on account of the outflows) at a loss in order to meet redemption requests, thus creating capital losses for the fund as a whole. As more outflows occur, the losses are concentrated among a smaller investor base. Strangely, investment managers are reluctant to advertise this benefit. Perhaps they are waiting until the fund is at the top of the pre-tax performance tables again. It's an easier sell.