Loss harvesting strategies tax efficiently diversify concentrated stock

Abstract

We analyze strategies that seek to tax efficiently transform a concentrated position to a diversified equity portfolio by running back-tests on hypothetical portfolios. The average 200/100 long/short diversification strategy tax neutrally reduced the active weight of a concentrated position to 5% or less in 10 years in all 380 historical scenarios we examined. This reduction was achieved with an average hypothetical after-tax active return of 1.34% per year, net of transaction costs, financing costs and management fees, relative to the option of holding the concentrated position. An investor who prefers to retain some exposure to a concentrated position may opt for lower leverage or a long-only strategy that relies on an annual gains budget. We map the empirically observed characteristics of diversification strategies to investors’ preferences, enabling asset managers and advisors to customize appropriately.