Schwab plans tax-aware long/short strategy as assets surge

Charles Schwab plans to launch its own version of a tax-aware long/short strategy, CEO Rick Wurster said on the brokerage's quarterly earnings call Thursday, as demand for products that help wealthy investors reduce capital gains taxes continues to grow.

The strategy, often called TALS, has attracted billions. Schwab's earnings included a $60.7 billion figure tied to tax-aware long/short strategies within margin loan balances. Those balances rose 14% quarter over quarter to $187.9 billion, the company reported. The $60.7 billion was related to strategies used by many registered investment advisers.

Wurster was responding to UBS analyst Mike Brown, who asked whether Schwab saw an opportunity to launch a proprietary solution given client demand and the growing number of funds in the category. 'I do expect us to have an offering,' Wurster said. He pointed to Schwab's existing direct indexing capability, saying it has performed well in delivering tax alpha, and said he expects Schwab to deliver an extended long/short version. He added that it could be another way to monetize services, but more importantly a way to offer sustainable long/short strategies that are operationally and financially manageable over the long term.

Assets in TALS have surged to more than $170 billion this year from $2 billion in 2022, according to an estimate Tax Alpha Insider provided to CNBC in September. The growth comes as years of stock market gains have left wealthy investors looking for more ways to shield capital gains, CNBC's Robert Frank reported. Business owners cashing out, executives with large stock compensation packages and employees at recently public companies face similar issues. For brokers and advisers, the products can carry relatively high fees and help attract wealthy clients.

Wealthy investors already use direct indexing on platforms including Schwab to pair gains and losses tax-efficiently. But standard tax-loss harvesting has a limitation: over time, fewer losses may be available to harvest. Kitces, an adviser research platform, explains that because markets tend to rise, most diversified portfolio positions eventually rise above their cost basis, so later downturns may not create taxable losses. Positions that keep falling can only generate a finite amount of losses because their value and cost basis cannot go below zero.

Tax-aware long/short strategies seek to address that by adding leverage on both the long and short sides of a portfolio. The investor buys more positions and increases the number of potential losses to harvest. Kitces notes this can keep the portfolio economically neutral, and because short positions can theoretically generate an infinite amount of losses when markets rise, TALS portfolios may be less likely to run out of losses than standard long-only portfolios.

Brent Sullivan of Tax Alpha Insider wrote on X Thursday that advisers will have many questions about Schwab's products. He said they should not be called 'funds,' a term UBS analyst Brown used. Sullivan said it is reasonable to speculate that a Schwab product could meaningfully lower the assets-under-management minimum typical for such products, but it remains unclear whether they will be available only to Schwab advisers and only on Schwab's platform.

Wurster gave few details and no launch timeline. 'We are thrilled about that, working on it, and we will give more updates in future calls as to when that may launch,' he said.

The government has taken a more aggressive stance on tax avoidance strategies, including some but not all 'tax alpha' approaches used by the wealthy. Treasury Secretary Scott Bessent and the IRS recently issued a notice about sophisticated ETF strategies used to shield capital gains. The notice also expressed interest in 'tax-aware' strategies typically structured as partnerships or separately managed accounts. According to an analysis by law firm Ropes & Gray, the notice made clear that 'tax-aware' itself is not a cause for concern and that year-end tax-loss harvesting is well-established.

Source: CNBC Top News.