CONTRIBUTORS
Ehren J. Stanhope, CFA
Co-Head of Investment Management, Chief Investment Strategist, Portfolio Manager
O'Shaughnessy Asset Management
Joseph Giroux
Managing Director, Porfolio Manager
O'Shaughnessy Asset Management
Executive summary:
- The structure of long-short strategies enables potentially larger and more consistent tax benefits than long-only direct indexing.
- Effectively managing a long-short strategy requires expertise in stock selection factors, leverage and tax management.
- Long-short strategies serve as a versatile tool for addressing various client objectives—loss harvesting, reinvigorating ossified portfolios,1 concentrated position workdowns and adding portable alpha without disturbing core holdings—and are a natural evolution of custom indexing.
A natural evolution for custom indexing
As we explain in this paper, it turns out that the direct indexing phenomenon, which took decades to incubate and took the investing world by storm in late 2019, is just the tip of the iceberg of taxable offerings. Custom indexing expanded tax aware solutions beyond the confines erected by legacy direct indexers—passive only with rigid funding requirements—while preserving the key benefit—the opportunity to maximize after-tax wealth.
Removing the long-only constraint in taxable accounts enables greater capital efficiency, fuller expression of stock selection opportunities, and a reduced reliance on client and market circumstances to generate tax benefits. With proper risk management, long-short capabilities can improve the probability of achieving multiple common investment objectives:
- Higher after-tax return potential with more consistent tax benefits
- Decreased incidence of tax lock, re-energize “ossified” portfolios
- Acceleration of concentrated exposure work downs
Furthermore, long-short strategies can be utilized in bespoke solutions for less-common, but complex objectives—portfolio overlays, prospective tax planning and completion portfolios.
To take full advantage of the capabilities that tax aware long-short provides, managers need to possess deep expertise in active stock selection, risk management, portfolio construction and tax management.
Long-short is the next logical step in extending the breadth of taxable custom investment solutions.
Endnote
- Ossified portfolios generally have large embedded unrealized gains, making it difficult for a manger to trade without realizing taxable gains.
WHAT ARE THE RISKS?
All investments involve risks, including possible loss of principal. Tax management practices may impact performance, portfolio characteristics and holdings; and may not result in favorable outcomes. Equity securities are subject to price fluctuation and possible loss of principal. Large-capitalization companies may fall out of favor with investors based on market and economic conditions. Leverage increases the volatility of investment returns and subjects investments to magnified losses and a decline in value. Short selling is a speculative strategy. Unlike the possible loss on a security that is purchased, there is no limit on the amount of loss on an appreciating security that is sold short.
Past performance is not a guarantee of future results. An investment in this strategy can lose value. Investors cannot invest directly in an index, and unmanaged index returns do not reflect any fees, expenses or sales charges.
WF: 6626008