When Charles Schwab released its quarterly results on Thursday, what caught the attention of those who manage money for wealthy stock investors was not the quarterly earnings per share printed on the numbers, but the $60.7 billion figure. It detailed margin loan balances, which increased 14% sequentially to $187.9 billion, including $60.7 billion related to so-called “tax-aware” long/short strategies used by many registered investment advisers.
These strategies are booming as a way for wealthy individuals to significantly increase their tax-deductible approach to stock gains and losses. TALS’ total assets jumped from $2 billion in 2022 to more than $170 billion this year, according to estimates provided to CNBC in September by Tax Alpha Insider.
Now, Schwab plans to carry out a larger portion of that effort. Schwab CEO Rick Wolster said on the earnings call, responding to a question from UBS analyst Mike Brown, that Schwab is launching its own version of a tax-aware long-short strategy.
“Clearly, tax-advantaged long/short products are a key driver of customer demand and asset collection across the industry. Given the increasing number of funds entering the market and given Schwab’s positioning and customer interest in this category, do you see an opportunity to launch your own solution?” Brown asked.
Schwab CEO’s statement
“I’m hopeful that we can provide something,” Wurster said. “We already have a great direct indexing capability that is currently performing excellently in terms of tax alpha and delivery to our clients, and we look forward to being able to offer an enhanced version of that in long/short. … It’s certainly another way that we can provide monetization, but more importantly, it’s a way that we can provide our clients with a sustainable long/short strategy in a way that is operationally and financially manageable over time,” Wurster said.
A recent report from CNBC Inside Wealth’s Robert Frank says that as the stock market continues to post strong gains for several consecutive years, wealthy individuals are looking for more ways to protect their capital gains from taxes. The situation is similar for executives who are cashing in or receiving large stock-based compensation packages, and for employees of companies that have recently gone public. For brokers and investment advisors, this product offers relatively high commissions and attracts new high-net-worth clients.
How these capital gains tax strategies work
Wealthy investors already use direct indexing strategies on platforms like Schwab to combine stock gains and losses in a tax-efficient way. According to a TALS overview from advisor research platform Kitces, the problem wealthy investors run into with standard loss recovery is that over time, they recover fewer and fewer losses. “On average, markets tend to rise, so in a diversified portfolio most positions will eventually rise significantly above their cost basis, and subsequent declines will not result in taxable losses; however, for positions that continue to decline, the actual amount of loss that can be generated is finite (because market value and cost basis can only fall to zero),” the report says.
Tax-aware long-short strategies avoid this problem by adding leverage to both the long and short sides of an existing portfolio, allowing investors to purchase more positions and increase the number of potential losses they harvest. This allows the portfolio to “remain economically neutral…and because short positions can theoretically generate infinite losses (losses diminish as the market rises), a TALS portfolio is less likely to run out of losses to recover over time than a standard long-only portfolio,” Kitches said.
Questions remain regarding access to tax risks
Tax Alpha Insider Brent Sullivan said in a post on X on Thursday that advisors will have a lot of questions about Schwab products, but noted they shouldn’t be called “funds,” and UBS analyst Brown used that term in his question. Sullivan wrote that while it is reasonable to speculate that Schwab’s products could “significantly lower” the minimum assets under management requirements typical of these products, it is also an open question whether the products will be available only to Schwab advisors and only on Schwab’s platform.
Wurster has provided few details and no release schedule. “We’re working on it and we’re excited about it. We’ll provide further updates in a future call as to when it will be launched,” he said.
The government has taken a more aggressive stance on the tax avoidance strategies of the wealthy and some, but not all, “tax alpha” strategies, with Treasury Secretary Scott Bessent and the IRS recently releasing a notice regarding the use of sophisticated ETF strategies to shield capital gains from taxation. The notice also expressed interest in “tax-aware” strategies, typically structured as partnerships or separately managed accounts, although analysis by law firm Ropes & Gray found that “tax-awareness” itself was not a cause for concern, and that year-end loss recovery is a well-established practice.
