Taxes have long had a significant impact on investor returns, eroding 1 to 2 percent or more per year according to a number of academic studies. Despite having roughly the same impact on returns as fees, taxes have often not received the attention they should as part of the investment planning, advice and implementation process. This is starting to change, however, as advisors and clients become more attuned to the impact of taxes on their investment portfolios.

For equity investors, the Tax Cuts and Jobs Act is misleadingly named. Federal tax rates for capital gains and qualified dividends, the sources of most of the returns generated in typical stock portfolios, did not change. In fact, for investors in states with a state income tax, the effective rate actually increased. The limitation on the deductibility of state and local income taxes means that taxes paid on gains and dividends at the state or local level may no longer be deductible.

Higher tax rates mean taxes take a bigger bite out of investor returns. The good news is that tax mitigation techniques can have more of an impact in reducing that tax drag. One common technique is tax-loss harvesting, or the selling of positions that have declined in value to realize those losses and offset other gains. Employing this technique is especially important this year, in part because of the Tax Cuts and Jobs Act, which went into effect January 1, 2018. That, along with the likelihood that recent market volatility has created more opportunities to harvest losses, is likely to result in much bigger demand for this service, which can strain the operations and trading staffs of asset managers that are not prepared.

This heightened focus on after-tax returns may also prompt clients and advisors to consider alternatives to mutual funds that offer structures with better tax characteristics. Separately managed accounts avoid the issue of embedded capital gains associated with commingled investment vehicles; they also facilitate customized investment decision-making to harvest losses and defer gains. Historically, separately managed accounts were cumbersome to use, but the proliferation of Unified Managed Accounts has removed many of those hurdles. As a result, asset managers may need to consider making their strategies available in other formats such as separate accounts and model delivery relationships.

Curt Overway is president and portfolio manager with Managed Portfolio Advisors, a division of Natixis Investment Managers.