AQR on the record: Critics don't understand tax-aware long/short
Answers to common questions about tax-aware long/short strategies
“…tax-aware long-short factor strategies provide two key advantages: the potential to outperform a passive index before tax and the ability to realize high net losses…”
If you’ve worked in institutional asset management, studied quant finance, or spent any time on Twitter, you have probably heard of AQR (short for “Applied Quantitative Research”). They manage ~$150 billion in client assets across global offices and are a fixture in quantitative investing.
While the past decade of direct indexing research has focused on tax-loss harvesting and minimizing tracking error, it has largely been an extension of a passive ethos.
Meanwhile, AQR has continued its work on pretax alpha generated through active trading with tax-efficient implementation, most notably in its tax-aware long/short strategies.
In 2011, they entered the taxable fray with “How Tax-Efficient Are Equity Styles?” and have published more papers on tax-aware implementation of pretax alpha strategies than anyone else.
Today, advisers recognize that tax is a practice differentiator and a source of recurring client value.
They may be torn between low-cost, passive index ETFs and direct indexing, but that debate fades into the background once they learn of tax-aware long/short strategies.
This post addresses common questions about tax-aware long/short strategies delivered in the separate account wrapper.
Tax-aware long/short strategies are white-hot
I predicted AUM might reach $30 billion by the end of 2025, but it has already surpassed $35 billion as of April. Latest AUM update…
AQR: Tax-aware long/short AUM ~$21.7 billion (3/31/2025)
Quantinno: Tax-aware long/short AUM ~$13 billion (source familiar)
BlackRock/Aperio: Tax-aware long/short AUM ~$1 billion
I will add figures from Parametric, Brooklyn, Gotham, etc. when I know more…
Nobody should care about tax benefits if there’s no pretax alpha
Long/short strategies allow managers to express a negative view on individual names, sectors, or factors. They deliberately deviate from a passive index to generate superior risk-adjusted returns per unit of tracking error.
Long/short strategies typically involve a lot of trading, especially when significant leverage is involved. Part of the cost of trading is tax. Tax-aware implementations realize capital losses but mostly defer capital gains to defray the cost.
Although the point of a long/short strategy is outperformance, the incidental tax benefits are substantial. This chart shows that, after 10 years, the average cumulative net tax losses of a highly leveraged long/short strategy were greater than 400% of the contributed capital, compared to less than 50% for direct indexing.
For the basics on tax-aware long/short strategies, see this article.
To understand why a tax-aware long/short strategy can deliver more capital losses than contributed capital, see the (imperfect, not advice, not a guarantee of results) infinite ball machine, which is an analogy for sustainable harvesting of capital losses via leverage and rebalancing.
Game changer or hype?
I wrote some common concerns that advisers and vendors have shared about tax-aware long/short strategies, and then the Internet happened.
Without a doubt, this stuff is complex. I’ve spent dozens of hours digging into the nuances, most recently with AQR staff, some adviser friends, and a few estate planners.
The questions about tax-aware long/short strategies usually fall into one of several categories:
Suitability
Pretax alpha and risk
Economic substance
Financing
Tax
Shorting
Custody
Estate