Why More Alpha Can Mean More Tax Benefits

There have been recent incidents of individuals and groups falsely claiming to be associated with AQR on social media platforms. These imposters have engaged in a variety of unauthorized conduct, including soliciting customers to carry out trading activities with them, impersonating AQR using the genuine names of AQR senior executives or employees to offer investment opportunities, claiming to offer investment training courses that are supposedly provided by AQR or claiming that AQR is backing certain initial coin offerings or is otherwise engaged in crypto related trading activity. There have also been fake websites and mobile applications that claim to be AQR (or associated with AQR) when in fact they are not. These are scams and not authorized by AQR in any way. Please be aware that AQR does not engage in any investment activities, provide training or financial services, or conduct other regulated activities through social media platforms or messaging apps. Similarly, AQR, its executives and employees do not contact prospects, clients or members of the public via social media platforms or messaging apps such as WhatsApp, Discord and Telegram to offer investment opportunities. AQR does not offer direct investments in cryptocurrencies or other digital assets, it does not provide a trading platform to members of the public, it does not have a mobile app, and it does not offer investment training courses to the public. AQR and its partners, employees, directors, officers, advisors, successors, and agents are not responsible for any conduct by unauthorized parties and channels, nor are they responsible for the services or information provided by such unauthorized parties and channels. If you have any questions or wish to ascertain whether you are communicating with an authorized representative of AQR, please contact us at https://www.aqr.com/Contact-Us. If you believe that you or someone you know has been a victim of fraud, please report the matter to your local law enforcement or other relevant authorities. For India residents, you may lodge a report at the national cybercrime reporting portal (https://cybercrime.gov.in). Education Research Cliff's Perspectives Alternative Thinking Data Sets Quick Takes Learning Center Subscribe Research Cliff's Perspectives Alternative Thinking Data Sets Quick Takes Learning Center Subscribe What We Do Our Approach Alternatives Equities Tax-Aware US Mutual Funds Australia Funds Flex UCITS Funds US Mutual Funds Australia Funds Flex UCITS Funds Our Approach Alternatives Equities Tax-Aware Our Firm About Us Leadership Careers Contact Us About Us Leadership Careers Contact Us MyAQR Log InRegister Log InRegister Contact Us Tax Aware

March 19, 2026 Topics - Tax Aware Tax-aware long-short strategies have sparked a debate: Are they simply direct indexing with leverage and shorting layered on to harvest more losses, or are they genuine alpha engines implemented in a tax-efficient way? Our latest paper, The Tax Benefits of Pre-Tax Alpha, tackles a surprisingly underexplored question: does pre-tax alpha help or hurt the tax benefits of tax-aware long-short strategies? Conventional wisdom drawn from direct indexing might suggest a trade-off. In long-only tax-loss harvesting, higher returns typically mean fewer losses to harvest. If markets rise broadly, there are simply fewer opportunities to realize losses. Following that logic, one might assume that more pre-tax alpha would lead to fewer tax benefits. That intuition turns out to be incomplete — and for long-short strategies, often wrong. It’s true that higher returns reduce tax losses as a percentage of assets. If everything is going up, fewer positions sit below cost. That basic arithmetic still applies. But higher alpha also accelerates NAV growth. Even if tax benefits shrink as a percentage of assets, they are applied to a larger and faster-growing base. In dollar terms, the benefits can actually increase. There’s another factor at work. Our paper highlights an underappreciated but powerful mechanism: alpha in long-short portfolios creates new positions. When a long-short strategy earns alpha, its leverage drifts below target. To rebalance, the manager must add new long and short positions. Those newly created positions start without embedded gains. In effect, alpha behaves like a recurring capital contribution — except without the investor needing to add new cash. This position-creation effect does not exist in traditional long-only direct indexing; it is unique to long–short implementations. The paper also examines an important practical question: do these alpha-driven tax benefits survive the transition from a long-short portfolio to long-only? The short answer is yes. Higher alpha reduces built-in gains relative to gross notional value in tax-aware long-short strategies. New positions dilute embedded appreciation, and the combination of higher alpha and higher leverage amplifies this effect. The practical implication is that transitioning to long-only becomes less costly from a tax perspective. Higher alpha not only increases pre-tax wealth; it can enhance tax benefits and reduce transition costs. Of course, all of this depends on actually generating alpha. If alpha is negative net of financing costs, transaction costs, and fees, tax benefits alone are not enough to justify the strategy, either pre-tax or after-tax. The conclusion is straightforward: in tax-aware long-short investing, alpha is not optional — it is central. Unlike in long-only strategies, pre-tax alpha in long-short portfolios does not undermine tax benefits; it amplifies them. The Tax Benefits of Pre-Tax Alpha Working Paper - March 18, 2026 Working Paper - March 18, 2026 Our Research into Tax-Aware Long-Short Investing Tax Matters - January 28, 2025 Tax Matters - January 28, 2025 Beyond Direct Indexing: Dynamic Direct Long-Short Investing Journal Article - May 3, 2023 Journal Article - May 3, 2023 Looking Under the Hood of Long/Short Tax-Aware Strategies Tax Matters - October 27, 2023 Tax Matters - October 27, 2023 This document 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. This document has been provided to you solely for information purposes and does not constitute an offer or solicitation of an offer or any advice or recommendation to purchase any securities or other financial instruments and may not be construed as such. The factual information set forth herein has been obtained or derived from sources b

AQR Capital Management, LLC, (“AQR”) provides links to third-party websites only as a convenience, and the inclusion of such links does not imply any endorsement, approval, investigation, verification or monitoring by us of any content or information contained within or accessible from the linked sites. If you choose to visit the linked sites, you do so at your own risk, and you will be subject to such sites' terms of use and privacy policies, over which AQR.com has no control. In no event will AQR be responsible for any information or content within the linked sites or your use of the linked sites.

You are about to leave AQR.com and are being re-directed to the {siteName}. Please note that {siteName} site may be subject to rules and regulations that may differ significantly from those to which the AQR website is subject and may not be appropriate for use by residents in all jurisdictions. Your access to and use of the {siteName} site will be subject to the applicable Terms of Use posted on the site.