In brief:
- Top active managers across U.S. equities have generated valuable returns over the past 20 years and significantly outperformed bottom-tier managers, highlighting the importance of choosing a manager with high potential to produce consistent strong performance.
- Active managers that incorporate tax management can help investors keep more of their returns by minimizing tax drag.
- Separately managed accounts (SMAs) offer the highest level of flexibility to optimize tax-management strategies.
- The benefits of a Tax-Smart SMA extend beyond tax-loss harvesting to tax-efficient transitions, managing concentrated stock positions and tax-optimized spending and gifting.
Active investment managers can provide two key benefits to their clients: generate returns above the market, known as “alpha,” and minimize tax drag to keep as much of total returns as possible. Investors can focus on selecting a manager with high potential to produce consistently strong returns and an account structure that can optimize tax-efficient strategies, such as a separately managed account. Generating strong returns—and saving more of it through tax management—can meaningfully boost long-term returns.
Only active management offers the potential to beat the market
Investing in top-tier active managers offers the greatest potential for wealth compounding: investors may have access to better returns than the market, which can mean generating higher returns in a strong market or losing less when stocks decline. Against a background of already buoyant equity markets, Exhibit 1 shows how $100,000 invested with a top-decile U.S. large cap blend manager would have grown to over $800,000 over a 20-year period. The result is even more dramatic in U.S. large cap growth, where $100,000 invested with a top-decile manager would have topped $1.2 million after 20 years.
However, the significant difference between the returns of top-tier and bottom-tier managers highlights the importance of choosing a good manager. The difference in cumulative performance between top-decile and bottom-decile managers over 20 years was as high as 616% in the U.S. large cap growth category and averaged 262% across equity categories.
Today’s market environment could make a strong active manager even more valuable. While rising market concentration has rewarded U.S. market cap-weighted index investments, we think it unlikely that the market will continue to compound at double-digit rates. In fact, J.P. Morgan Asset Management’s long-term capital market assumptions for 2026 forecast U.S. equities at 6.7. In an environment where market returns are lower, excess return from active management becomes a more important component of total return.
Select a manager that can generate strong returns over time
How should investors consider an active manager? A first step is to look for broad-based, consistent performance over time, including relative performance vs. the benchmark and comparable investment strategies. For example, in U.S. equities, approximately 77% of J.P. Morgan Asset Management’s assets under management (AUM) has earned the highest rating—five stars—from Morningstar.1 Relative performance has been exceptionally strong, with 92% of AUM ranking in the top two quartiles vs. competitors and 93% of AUM beating the benchmark over the last decade.
Investors should also consider a manager’s resources and ability to generate returns above a benchmark. In the case of J.P. Morgan Asset Management, the active investment strategies center around a commitment to research. The equities platform alone has been trusted to manage over $1 trillion in AUM, with over $800 billion in U.S. equities.2 Resources include a global research budget of over $150 million and 70 global career research analysts that cover over 2,500 companies.3 This commitment to driving alpha through strong fundamental research is being recognized by investors: J.P. Morgan Asset Management ranked #1 in flows into both active management and active equities in 2024.4
Consider the potential for tax management when choosing a strategy
A high-performing active manager can produce the greatest amount of compounding wealth. However, investors risk losing some of those hard-earned returns if they have not considered the impact of taxes.
One way to get a more tax-efficient investment experience is to invest in an active ETF. ETFs have potential to defer capital gain distributions, which would leave investors to realize gains primarily when they sell out of their shares of the ETF. For investors looking for an efficient and straightforward way to get exposure to an active investment strategy this option can reduce tax drag each year while the investment is held.
However, some investors are looking for greater customization and flexibility, perhaps due to the size of the portfolio, a concentrated stock position, or the desire to further optimize returns. Tax-Smart SMAs offer access to J.P. Morgan’s active investment strategies through a portfolio tailored to each individual client. These customized portfolios align with specific financial needs and tax considerations, offering further opportunities to proactively harvest losses to offset gains.
Tax-Smart SMAs start retaining returns by harvesting losses
A key benefit for Tax-Smart SMA investors is the ability to tax-loss harvest at the individual stock level, rather than at the fund level. That’s an important feature particularly in a rising market, when a portfolio may have generated positive returns in aggregate, but not necessarily across every stock in the portfolio. A tax-aware manager who is trimming or selling out of a position to manage risk or deliver alpha can potentially realize losses that might be available to offset realized gains from that activity (Exhibit 2).
To illustrate the potential impact of tax management, we simulated a monthly tax-loss harvesting approach on actively managed SMA strategies across different styles looking at five-year periods with starting years from 2003 to 2019.4 The results show an improvement in after-tax returns of roughly 100-120 basis points (Exhibit 3). For a tax-sensitive investor, a Tax-Smart SMA is a forward-thinking way to preserve alpha.
Natural turnover from portfolio manager decisions can continuously create new tax lots, resetting the cost basis and refreshing the opportunity to tax-loss harvest. In comparing and contrasting the profile of tax benefits across index-tracking and active tax-smart strategies, we see that index-tracking strategies may offer a higher tax benefit in the early years before the pace of loss harvesting slows down. However active strategies have more opportunities in the later years (Exhibit 4).
Tax benefits extend beyond loss harvesting
The benefits of a Tax-Smart Active SMA extend beyond tax-loss harvesting. The flexible nature of an SMA can provide tax benefits as investors enter and exit the strategy because Tax-Smart SMAs can be funded with a variety of assets in kind, including individual stocks, ETFs and mutual funds.
For example, an investor may wish to exit a poorly performing strategy but may be concerned about triggering a significant tax liability. A Tax-Smart SMA offers a more tax-efficient alternative than liquidating the account’s positions to fund a new strategy. If many of the existing positions closely align with those in the replacement strategy, the positions can be redeemed in kind and transferred directly to the new strategy, reducing both the need to trigger capital gains via sales and repurchase similar securities (Exhibit 5). For positions that do not fit into the new strategy, a Tax-Smart SMA can defer selling until losses are realized in the account, allowing those losses to offset gains and minimize the tax impact.
This same strategy can be used to diversify away from a concentrated stock position or existing mutual fund or ETF positions in a more tax-efficient way. The process of fully aligning existing positions with the new strategy may take time, depending on the selected strategy and market opportunities for tax-loss harvesting, but clients maintain control over their tax liability throughout the transition.
In the later phase of an account’s lifecycle—the distribution phase—an SMA provides flexibility to optimize the unique unrealized gains and losses when selling positions to raise cash for a withdrawal. For example, an investor can use lots with lower unrealized gains when raising cash and use lots with higher unrealized gains for gifting (Exhibit 6). For a strategy that has built up large unrealized gains from appreciated stocks over the years, this strategy can provide a significant difference in tax liability compared to a pooled vehicle.
Picking the right active manager is an important decision that deserves time and diligence as the difference between the top and bottom performers can significantly impact returns. The right manager should not only deliver results but also include a tax-efficient approach to help retain more of a portfolio’s returns, further enhancing and preserving the benefits for investors.