Alpha Now, Taxes Later: Tax-Efficient Long-Only Factor Investing
34 Pages Posted: 13 Aug 2023 Last revised: 18 Aug 2023
Date Written: August 18, 2023
It is widely believed that factor investing typically requires high turnover, which increases the tax burden, rendering the factor alpha unobtainable in taxable accounts. Using 98 simulated backtests of a 10-year investment horizon spanning from 1964 to 2021, we find that value, quality, and safety buy-and-hold portfolios were able to generate significant pre-tax and after-tax alphas. Based on this observation, we construct a composite factor using these three factors. The composite factor portfolios consistently outperformed the benchmark in more than 80% of the simulated backtests without any rebalancing. Their performance can be further improved by allowing trades so long as they do not realize any net capital gains, such as tax loss harvesting and selling factor losers only when they do not carry any capital gains. Our results provide a simple and robust portfolio solution for a broad range of tax-conscious investors.
Keywords: Tax-managed Investment, Alpha Factors, Portfolio Construction, Tax Alpha, Loss Harvesting, Quantitative Strategies, Long-only Investing
JEL Classification: D14, G11, H21
Suggested Citation: Suggested Citation