Loss Harvesting or Gain Deferral? A Surprising Source of Tax Benefits of Tax-Aware Long-Short Strategies

35 Pages Posted: 18 Oct 2023

See all articles by Stanley Krasner

Stanley Krasner

AQR Capital Management, LLC

Nathan Sosner

AQR Capital Management, LLC

Date Written: September 26, 2023

Abstract

Liberman et al. (2023) showed that tax-aware long-short factor strategies, within the first three years since inception, can realize cumulative net capital losses exceeding 100% of initially invested capital, all while generating a significant pre-tax alpha. This paper explores the mechanism behind these remarkable results. Surprisingly, in tax-aware long-short factor strategies, net capital losses arise not from an increased realization of capital losses but rather from the deferral of capital gains, especially short-term gains on long positions. Despite reducing the gain realization, these strategies still allocate most of their turnover to trading in the direction of the alpha model, which explains their strong pre-tax performance. To achieve alignment with the alpha model, these strategies mostly rely on creating new positions and liquidating loss positions while avoiding the liquidation of gain positions.

Keywords: Direct Indexing, Long-Short Strategies, Factor Investing, Tax-Aware Strategies

JEL Classification: G11, G51, H24, K34

Suggested Citation

Krasner, Stanley and Sosner, Nathan, Loss Harvesting or Gain Deferral? A Surprising Source of Tax Benefits of Tax-Aware Long-Short Strategies (September 26, 2023). Available at SSRN: https://ssrn.com/abstract=4584287 or http://dx.doi.org/10.2139/ssrn.4584287

Stanley Krasner

AQR Capital Management, LLC ( email )

One Greenwich Plaza
Greenwich, CT 06830
United States

Nathan Sosner (Contact Author)

AQR Capital Management, LLC ( email )

One Greenwich Plaza
Greenwich, CT 06830
United States

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