The Tax Benefits of Relaxing the Long-Only Constraint: Do They Come from Character or Deferral?
The Journal of Wealth Management, Spring 2019, 21 (4) 10-31; DOI: 10.3905/jwm.2019.1.068
48 Pages Posted: 25 Oct 2018 Last revised: 31 Jan 2020
Date Written: December 6, 2018
In this study we propose a decomposition of the total tax benefit (or liability) of a strategy into what we define as character and deferral components. Our decomposition is mathematically straightforward and intuitive and allows for a quick and informative assessment of tax benefits of different tax-aware strategies without modeling various investor-specific situations. We use this character-deferral decomposition to identify the source of tax benefits resulting from relaxation of the long-only constraint. Our empirical evidence shows that for tax-aware strategies relaxing the long-only constraint results in a large increase in their tax benefits in particular due to an increase in the character benefit. We conclude that tax-aware relaxed-constraint strategies are more attractive to taxable investors than their long-only counterparts and provide some caveats to this conclusion.
Keywords: Tax-Aware Portfolio Management, Active Management, Quantitative Strategies, Relaxed-Constraint Strategies
JEL Classification: G11, H21, H24
Suggested Citation: Suggested Citation