Tax Management of Factor Based Strategies

Tax Management of Factor-Based Portfolios

The risk-adjusted returns of factor strategies can look quite attractive. However, the turnover associated with them can significantly reduce their after-tax excess returns. In this article, we report the results of our after-tax study of these strategies. From an after-tax perspective, we find that taxes can erode much of this return unless we overlay a systematic tax management process. Although there exist vast amounts of empirical literature on the potential excess return benefits of using systematic factors in investment portfolios, much less is known about the tax impact on the returns of these portfolios. 

What is Factor-Based Investing? 

Factor-based investing begins with the premise that the differences in stock returns can be explained by a set of common factors. Relative to a market-capitalization-weighted portfolios, the factor-based portfolio emphasizes certain factors in order to enhance returns. Widely used factors include size, value, momentum, quality, low volatility, dividend yield, and profitability.

 

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Rey Santodomingo

Rey Santodomingo, CFA

Director of Investment Strategy – Tax Managed Equities
Rey Santodomingo

Rey Santodomingo, CFA

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