Tax management is the new frontier for active investing

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Guidance is the key. Alpha is one thing, but tax alpha? Yes, please. An experienced advisor can navigate through the world of SMAs, active ETFs, and directing indexing. Learn about opportunities to help keep more of what you earn.

For decades, the conversation around investing was relatively straightforward. Investors picked a strategy (like value, growth, or income) and then chose a vehicle to hold it, usually a mutual fund. The focus was almost entirely on investment alpha— which is essentially beating the market. But as the financial tables turn, a second layer of complexity has emerged that is just as critical to long-term success: tax management.

The industry has moved far beyond the simple. We are now navigating a world populated by separately managed accounts (SMAs), exchange-traded funds (ETFs), direct indexing, and various alternatives. This explosion of choice isn’t simply about having more options; it’s about matching the right vehicle to the specific needs of the investor and type of account.

At the center of this shift is the sobering realization that the best investment strategy in the world can stumble if the tax implications aren’t managed carefully. At the end of the day, it’s not about the performance on the fact sheet, it’s about what you ultimately keep.

There’s a not-so-new kid in town

SMAs have become popular again, and are getting a lot of attention. They’ve been around since the 1970s but have recently seen some rapid growth, particularly alongside the rise of the fee-based advisory model where you sit on the same side of the table as your financial advisor. You make more, they make more. Unlike a mutual fund where investors share a pooled portfolio, an SMA allows for direct ownership of individual securities.

This structure aims to offer a distinct advantage for tax efficiency. Because the investor inherits the stock at their specific purchase price rather than a manager’s original cost basis, the portfolio can be tailored to harvesting losses and possibly offsetting gains. This ability to generate “tax alpha”—returns derived from tax savings rather than market movement—is becoming a popular driver for advisors and clients alike.

This level of customization requires a single advisor to avoid complications like wash sales across accounts so you can pay as little as possible to Uncle Sam, And it underscores a broader truth: Complexity demands guidance.

The SEC stepped on the gas

On the other side of the equation, the ETF market has undergone a transformation of its own. Since the Security and Exchange Commission’s (SEC) 6c-11 rule in 2019 streamlined the regulatory framework, the proliferation of ETFs has accelerated dramatically. Last year alone saw hundreds of new launches, with active managers now accounting for a majority of those new offerings. In fact, there are currently more ETFs than individual stocks, and for the first time, active ETFs outnumber passive ones.

And yet, misconceptions persist. Many people still view ETFs as a monolith of passive index tracking. Active ETFs have been around for nearly 20 years, stress-tested through multiple market cycles, and utilized by the Federal Reserve during the pandemic stimulus. The modern ETF offers three distinct advantages, often called the “three T’s”: transparency, tradability, and tax efficiency.

The in-kind delivery mechanism inherent to the ETF structure helps avoid capital gain distributions, while the market-maker system is designed to ensure liquidity and tight spreads. So, what does all that mean? It means ETFs are flexible enough to adapt to market shifts without triggering unnecessary tax events. Tax events of any kind are triggering enough.

SMAs, ETFs, customization, custodians, and finding the right vehicle? It’s a lot.

The missing link

We’re talking again, of course, about guidance. With over 800 new ETFs launching annually and the rise of complex SMA structures, the sheer volume of choices can be paralyzing. And this is where the role of the advisor evolves from a person who helps you pick stocks to a strategic partner.

The dynamic between client and advisor has changed due to the shift toward fee-based models. Now both are on the same side, moving away from one-time transactional revenue toward a recurring model focused on holistic client relationship management. Advisors now do much more than simply pick funds. You could think of them as portfolio architects.

Unified managed accounts (UMAs) exemplify this approach, combining individual stocks, bonds, ETFs, mutual funds, and SMAs into a single portfolio. You might think of these as competing products, but you’d be wrong. They’re complementary tools deployed based on specific client needs. An advisor might use an active ETF for broad market exposure, an SMA for tax-loss harvesting on specific holdings, and direct indexing for personalized customization.

Beware: Be tax-aware

MFS Investment Management was founded in 1924 and has watched this evolution unfold since then. As the launchpad for the first open-end mutual fund in the US, they understand that the vehicle is only as good as the strategy it carries.

Today, that strategy must be paired with technology and infrastructure to ensure tax-awareness. Whether through MFS’s established investment teams managing active ETF strategies or their infrastructure for volatility management, the goal remains consistent: Help investors keep more of what they earn. MFS leverages their partnerships with tenured liquidity providers as well as wealth management platforms along with their deep experience in fixed income and equity markets to navigate the complexities of today’s investing world.

The tech behind these solutions is also maturing. Advanced systems now match realized gains with harvested losses in real time, creating tax alpha that active management naturally facilitates through the creation of diverse tax lots. But tech alone isn’t enough. It requires an advisor to coordinate these efforts, ensuring that tax harvesting in one account doesn’t trigger a wash sale in another.

Respect the tax code

SMAs and ETFs used to be niche alternatives. But look at them now. They represent the evolution of modern, more tax-efficient portfolios. But with great flexibility comes great responsibility.

The path to keeping more in an investment portfolio and less in taxes isn’t paved with algorithms. It requires the insight of experienced professionals who understand how to weave these complex vehicles into a cohesive strategy. When a tax bill can erode a significant portion of portfolio returns, the most valuable asset a portfolio can hold isn’t a stock or a fund. It’s guidance.

MFS does not provide legal, tax, or accounting advice. Individuals should not use or rely upon the information provided herein without first consulting with their tax or legal professional about their particular circumstances. Any statement contained in this communication (including any attachments) concerning U.S. tax matters was not intended or written to be used, and cannot be used, for the purpose of avoiding penalties under the Internal Revenue Code. This communication was written to support the promotion or marketing of the transaction(s) or matter(s) addressed. The views expressed in this article are those of MFS, and are subject to change at any time. These views should not be relied upon as investment advice, as securities recommendations, or as an indication of trading intent on behalf of any MFS investment product.