Advisors searching for low tax investment vehicles for their clients’ taxable accounts need to look beyond ETFs, according to Frank Pape, director of consulting services for Russell Investments and a CPA.

Although ETFs are more tax efficient than actively managed mutual funds, they lose more dollars to taxes than tax-managed funds, says Pape, who spoke at Envestnet’s recent Advisor Summit in Grapevine, Texas.

“It’s after-tax returns that make the difference,” said Pape.

Over the five years ended March 31, the average actively managed U.S. large-cap mutual fund lost 1.5% annually to federal taxes among investors in the top marginal tax bracket (43.4%, which includes the Affordable Care Act surtax), while the average passively managed index fund or ETF lost 0.95%, based on Morningstar data, said Pape. In comparison, the firm’s tax-managed U.S. Large Cap Fund lost just 0.38%.

The average actively managed U.S. small-cap fund lost 1.74% to taxes for the highest taxed investors while passively managed funds lost 0.87%; the tax-managed mid- and small-cap fund lost 0.73%.

“Left unmanaged, a hidden tax expense of funds can be more than the fee an advisor is charging his or her client,” says Pape.

In addition to Russell Investments, many other fund companies offer tax-managed funds including Vanguard, Fidelity, Eaton Vance and Bernstein.

These funds try to minimize the taxes which can come from multiple sources but mostly fit into two categories: sales of assets — due to turnover, change of portfolio managers, redemptions — and payments of dividends (in stock portfolios) and yield (in bond portfolios). Sales can also increase trading costs for funds.

Tax-advantaged funds limit their tax liabilities by offsetting capital gains with losses, harvesting losses throughout the year as the opportunities arise and avoiding wash sales; by carefully overseeing the holding period of assets so that any sale qualifies for the lower long-term, rather than short-term, capital gains rate; and managing dividend-yielding stocks so they have lower yields or yields that qualify for the lower long-term capital gains rate. Funds that use subadvisors to manage assets can also minimize their taxation by centralizing purchases and sales of assets in order to limit taxable gains, says Pape.

He suggests that advisors choosing mutual funds focus on the after-tax returns, which can be easily found on Morningstar’s fund pages, keeping in mind that the after-tax returns are based on the highest marginal income tax bracket, per the Securities and Exchange Commission. Comparing after-tax returns to pretax returns can also be eye-opening.

Advisors should also understand that turnover is not necessarily a negative with tax consequences. Turnover is also affected by sales of assets to harvest losses, says Pape.

Advisors also need to know that not all funds calling themselves “tax-managed” will always live up to their name. “Even though a fund says in its prospectus that it tries to limit investors’ exposure to income and capital gains, that doesn’t mean it always can,” according to a recent Morningstar article by Karen Wallace. Shareholder redemptions and manager turnover (a new manager remakes the portfolio) “can lead to increased selling and subsequent distributions to shareholders.”

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