Taxes, Shorting, and Active Management

We examine the consequences of short selling in the context of quantitative investment strategies held by individual investors in taxable accounts. Short positions not only allow investors to benefit from the anticipated underperformance of securities but also create tax benefits because they enhance opportunities to time capital gains realizations. Relaxing short-selling constraints results in tax benefits because a portfolio’s long positions tend to realize net long-term capital gains taxed at relatively low rates, whereas short positions tend to realize net short-term capital losses, which can offset short-term capital gains from other strategies in the investor’s portfolio. Our results show that investment strategies that take advantage of short selling can generate superior after-tax performance by significantly reducing the tax burden. Disclosures: The views expressed in this article are those of the authors and do not necessarily reflect the views of AQR Capital Management, LLC. Further information can be found at the end of this article. Editor’s Note Submitted 27 January 2017 Accepted 27 March 2017 by Stephen J. Brown Disclaimer: The views and opinions expressed are those of the authors; do not necessarily reflect the views of AQR Capital Management, its affiliates, or its employees; and do not constitute an offer, solicitation of an offer, or any advice or recommendation, to purchase any securities or other financial instruments, and may not be construed as such. Nothing contained herein constitutes investment, legal, tax, or other advice, nor is it to be relied on in making an investment or other decision.