Seeking Answers to Scary Questions
I am what some would call a nerd – but don’t feel bad for me, I wear this as a badge of honor. As such, I am not normally afraid to work with data and perform deep analysis. However, there was one time where the thought of diving deeper gave me pause for fear of what I might find. In hindsight, my hesitation seems silly given the critical truth I was overlooking. Nevertheless the anxiety was real. For fellow nerds, this is also known as Confirmation Bias, but I digress.
At Blueprint, we incorporate a tactical approach to asset management allowing us to employ not only traditional asset diversification but also what we call time-diversification. We have repeatedly seen that this additional source of diversification has repeatedly enhanced risk-adjusted returns while lowering volatility and minimizing drawdowns of capital during market stress. We have found these benefits to be compelling to the advisors and institutions with which we wish to partner.
“But what about taxes?”, we often hear. It is a fair question given the normal experience with tactical strategies.
I am confident few questions strike fear in the heart of a tactical asset manager more than this one. For non-taxable accounts, this is not an issue of course, but for all others it is vitally important, since the only returns that truly matter are the after-tax variety. See, you can’t eat pre-tax returns. It is the after-tax dollars that count. Failure to adequately address the tax question to an advisor, who might typically use only tax-friendly strategies, is not an option.
So, what about that critical truth that I overlooked? Well, as it turns out the foundation of our strategies is the concept of “selling losses quickly and riding (holding) our winners”. While we are indeed tactical, we intentionally choose longer time frames due to our focus on capturing the overwhelming majority of equity bull markets. The combination of selling losses quickly (within a month or so) while holding winning positions for years, if they persist, fits nicely with US capital gains tax law.
Despite initial skepticism, my analysis confirmed the critical truth, which has allowed us to tout the benefits of a long-term tactical approach from not only a performance perspective, but also in terms of tax-efficiency. Time Diversification aka Long-term Trend Following, was utilizing tax loss harvesting long before it was cool. While it will not always be true, there are years in which our approach will add tax alpha in a systematic way while also producing a positive return superior to a buy-and-hold benchmark.
After over a decade of examining performance data in everything from stocks to cotton futures, I’m still excited to engross myself in the numbers, but rarely surprised anymore by what I find. The combination of this fact along with my initial anxiety is what makes this particular research stand out in my mind.
And I believe this is truly worthy of sharing with our readers. At all times we are seeking the truth, not just good news…but it’s nice when you get both.
For specific details of our tax analysis, please click here.