Tax Aware

Understanding the Tax Efficiency of Market Neutral Equity Strategies

Topics - Tax Aware Alternative Investing Market Neutral

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Understanding the Tax Efficiency of Market Neutral Equity Strategies

Market neutral equity strategies can be very tax efficient. Not only can they have low tax burdens, but they can also yield tax benefits. These tax benefits can be further increased through tax-aware rebalancing. Importantly, in our paper we find that tax-aware market neutral strategies achieve these tax benefits with only a small degradation in pre-tax returns.

What’s Inside

  • We explain why market-neutral strategies can be inherently tax-efficient, and illustrate this through historical strategy simulations of pre-tax and after-tax performance of tax-agnostic and tax-aware market neutral strategies.
  • The tax-agnostic strategy, instead of realizing tax liabilities, on average realizes a small tax benefit resulting from short-term capital losses on short positions.
  • Tax awareness further improves tax outcomes. By deferring the realization of capital gains and accelerating the realization of capital losses, the tax-aware strategy realizes tax benefits similar in magnitude to pre-tax returns.
  • The tax benefits of the tax-aware market neutral strategy are high and persistent over time. Additionally, they are positively correlated with the market return, implying there are greater tax benefits in bull markets, exactly when they are needed the most.
  • We conclude with potential practical applications of tax-aware market neutral strategies including: diversification of portfolio returns, increasing the overall portfolio tax efficiency through realization of capital losses, and diversification of concentrated low-basis positions.


Market neutral equity strategies can be very tax-efficient because short positions give rise to opportunities for realizing short-term capital losses. Adding tax-aware portfolio construction can further improve after-tax returns, and may even yield tax benefits similar in magnitude to pre-tax alpha. Moreover, our study finds that tax benefits of the tax-aware market neutral strategy can persist in the long run and are positively correlated with market returns. Based on these results, we conclude that tax-aware equity market neutral strategies can be an important tool in the toolbox of a taxable investor from both the tax and pre-tax perspectives.

Published In

Alternative Investment Analyst Review

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The information contained herein is only as current as of the date indicated, and may be superseded by subsequent market events or for other reasons. The views and opinions expressed herein are those of the author and do not necessarily reflect the views of AQR Capital Management, LLC, its affiliates or its employees. This information is not intended to, and does not relate specifically to any investment strategy or product that AQR offers. It is being provided merely to provide a framework to assist in the implementation of an investor’s own analysis and an investor’s own view on the topic discussed herein. Past performance is not a guarantee of future results.


Hypothetical performance results have many inherent limitations, some of which, but not all, are described herein. The hypothetical performance shown was derived from the retroactive application of a model developed with the benefit of hindsight.  Hypothetical performance results are presented for illustrative purposes only.


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