Making Tax-Aware Long-Short Investing Accessible: How alphaAI Uses ETFs to Unlock Scalable Tax Alpha for More Investors

TL;DR

1. Tax drag quietly reduces your returns — even if you’re a smart investor.
2. Direct indexing (DI) helps, but its benefits shrink over time. Studies show that DI tax losses max out at 30% of the principal value over the entire lifetime of the strategy.
3. Tax-aware long-short strategies (TALS) can generate far more tax savings and better pre-tax performance. Research shows that TALS can generate 10x more tax losses than DI, consistently year-after-year, with no drop off.
4. The catch? Old-school TALS is complicated and requires a $1 million minimum. Only hedge funds and ultra-wealthy investors could afford it.
5. alphaAI’s breakthrough: We’ve built an ETF-based TALS framework that keeps the benefits but removes the barriers. Using ETFs instead of individual stocks makes TALS far simpler, more cost-effective, and accessible to investors with as little as $20,000.
6. This gives you a smarter way to offset gains, smooth taxes, and build wealth — with institutional-level tax alpha that was once out of reach.

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Overview

For years, some of the world’s best investors — think hedge funds and ultra-high-net-worth families — have used tax-aware long-short (TALS) strategies to reduce taxes and boost overall returns. Research shows these approaches often outperform popular tax tactics like direct indexing, but they’ve remained out of reach for most people due to high minimums (usually $1 million), operational hurdles, and complexity.

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At alphaAI, we believe these advantages should be accessible by everyone. That’s why we’ve built an ETF-based version of TALS that makes this powerful tool more accessible, easier to manage, and suitable for accounts starting at $20,000, not $1 million.

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This paper explains the thinking behind our approach, what the research says, and how using ETFs instead of hundreds of individual stocks can help everyday investors achieve tax alpha that was once only possible for institutional players.

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Why Tax-Aware Investing Matters — and Why It Needs an Upgrade

Most investors know taxes can quietly eat away at returns. That’s why tax-loss harvesting (selling investments at a loss to offset taxable gains) has grown so popular. Direct indexing has made this easier by letting investors own each stock in an index instead of a single ETF or mutual fund, creating more opportunities to harvest losses.

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But research increasingly shows that direct indexing has limits. As positions gain value over time, the pool of losses shrinks. This creates a “diminishing returns” effect that means its tax benefits tend to flatten out after the first few years.

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Recent studies, including work by Krasner and Sosner (2024) and Liberman et al. (2023), show that tax-aware long-short strategies can overcome this problem by weaving in short positions. When you combine long (buy) and short (sell) trades, you naturally generate losses through the normal rebalancing and factor rotation, not just deliberate tax trades.

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In fact, these studies show that well-run TALS portfolios can create cumulative net capital losses exceeding 100% of the original investment within three years. By comparison, direct indexing strategies often max out around 30% in net losses over their lifetime.

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And it’s not just about tax savings. TALS frameworks are typically built on factor investing — such as value, momentum, or quality factors — allowing them to target pre-tax outperformance as well. That’s a double benefit: you get higher pre-tax returns plus better after-tax results.

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The Problem: Complexity and Exclusivity

If TALS is so powerful, why hasn’t everyone used it? The problem has always been complexity. Traditional versions rely on:

• Selecting and managing hundreds of individual stocks
• Running margin accounts and maintaining short positions
• Sophisticated accounting for tax lots and wash sale rules
• High levels of ongoing portfolio rebalancing

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All of that translates into high minimums — often $1 million or more — and operational overhead that only big institutions or UHNW investors can handle. For the typical retail investor (or even many advisors), it’s simply not practical.

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There’s also the issue of overlap with a client’s other holdings. For example, an investor with a large legacy stock position may not want to short related companies. Custom TALS accounts can be inflexible and tough to integrate with other strategies.

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The alphaAI Solution: Using ETFs to Unlock TALS for More Investors

Our solution is simple in principle but powerful in practice: swap the individual stock positions for carefully chosen ETFs.

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By building long and short exposures with liquid ETFs instead of hundreds of stocks, we maintain the core mechanics of TALS — gain deferral, loss harvesting, factor exposure — but make it dramatically simpler and more scalable.

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Example: Imagine an investor wants exposure similar to the S&P 500. Instead of holding 500 individual companies, we might go long 200% SPY and short 100% VOO (both are ETFs that track the S&P 500). The net exposure matches the benchmark, but the short side generates capital losses as the market moves. When needed, we can swap the short ETF for an alternative to realize losses while maintaining index exposure.

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This approach is flexible. Our AI models can customize the strategy to match different benchmarks, generate alpha, or even target a specific level of portfolio risk.

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What Makes ETFs Ideal for This

Using ETFs instead of individual stocks solves many of the biggest problems that kept TALS exclusive:

• Deep liquidity & low costs: ETFs are easy to trade, have tight bid-ask spreads, and are cost-effective to maintain.
• Simplified accounting: You don’t need complex tax-lot tracking across hundreds of tickers — positions are fewer and easier to manage.
• Flexible implementation: It integrates smoothly into advisory workflows and custodial platforms — no need for hedge-fund infrastructure.
• Lower minimums: Instead of $1 million, accounts can start with as little as $20,000, making this option accessible to many, many more investors.
  
  

Our backtests show that our ETF-based TALS framework can deliver cumulative net capital losses similar to traditional TALS, while also providing the same ability to defer gains and pursue pre-tax alpha.

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Use Cases for Smart Tax Management

The biggest benefit of our ETF-based TALS approach is its flexibility in how you use the generated losses:

• Offset short-term capital gains: Active traders can use harvested losses to offset taxes on winning trades.
• Manage windfall events: Selling a business, real estate, or large stock position? Use TALS to cushion the tax hit.
• Smooth income in retirement: Even if you don’t have big gains, you can offset up to $3,000 of ordinary income each year and carry losses forward.
• Build a loss bank: Losses can be carried forward indefinitely, so you can use those losses strategically in future years. You should start building your loss bank as early as possible.

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When you’re ready to transition out, you can unwind the strategy into a long-only allocation, which can qualify for the more favorable long-term capital gains rates, or adapt the “long” side into your preferred investment approach.

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What This Means Retail Investors

Until now, TALS strategies were a custom solution for institutions and hedge funds. By using ETFs, we’ve made them operationally simple and scalable for everyone. Retail investors can finally access tools that used to be reserved for the Wall Street elite.

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As more of the industry shifts toward tax-smart portfolio design and personalized rebalancing, we see ETF-based TALS as a natural next step.

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Conclusion

Taxes shouldn’t be an unavoidable drain on your returns. While direct indexing was a step forward, the data shows that tax-aware long-short strategies have the potential to go further, generating consistent tax savings and improving pre-tax performance.

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By rethinking TALS with ETFs and AI-powered models, alphaAI Capital makes this once-exclusive approach available to everyday investors and forward-thinking advisors. The goal: keep more of what you earn, year after year.

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If you’d like to learn how this could work for you, we’re always here to help.

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References

1. Krasner, S., & Sosner, N. (2024). Loss Harvesting or Gain Deferral? A Surprising Source of Tax Benefits of Tax-Aware Long-Short Strategies. The Journal of Wealth Management.
2. Liberman, J., Krasner, S., Sosner, N., & Freitas, P. (2023). Beyond Direct Indexing: Dynamic Direct Long-Short Investing. The Journal of Beta Investment Strategies.
3. Sosner, N., Gromis, M., & Krasner, S. (2022). The Tax Benefits of Direct Indexing: Not a One-Size-Fits-All Formula. The Journal of Beta Investment Strategies.
4. Israel, R., & Moskowitz, T. (2012). How Tax Efficient Are Equity Styles? Chicago Booth Research Paper No. 12-20. SSRN: http://ssrn.com/abstract=2089459.
5. AQR Capital Management. (2024). Our Research into Tax-Aware Long-Short Investing: Clarifying a Few Important Things. https://www.aqr.com