Tax-Aware Long-Short Investing: A Better Alternative to Direct Indexing for Smarter After-Tax Returns

TL;DR

• Direct indexing is a good start for tax savings, but it loses steam fast and is limited by its “long-only” nature.
• New research shows that Tax-Aware Long-Short (TALS) strategies can deliver much more in tax savings and higher pre-tax returns by deferring gains and naturally generating losses.
• Studies show that direct indexing generates a max of 30% of your principal value in losses over the entire lifetime of the strategy. By contrast, TALS can generate 10x more in tax losses than direct indexing with no drop off.
• Until now, TALS has been complex, expensive, and only for institutions, but new tech and ETF-based models from alphaAI Capital are changing that.
• If you want to keep more of your returns, reduce tax drag, and stay flexible, TALS may be a superior alternative to direct indexing.
  
  

Why Investors Have Been Turning to Direct Indexing — and Where It Falls Short

For years, direct indexing has been the “next big thing” in tax-efficient investing. The idea is simple: instead of buying a single index ETF or mutual fund, you buy all the individual stocks that make up an index. This lets you sell underperforming stocks to lock in losses that can cancel out gains elsewhere, which can help you pay less tax.

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It works — but only for a while. Direct indexing is built on one thing: harvesting losses when the market (or certain stocks) dip. The problem is that this pool of losses naturally dries up. Once those stocks appreciate and stay up, you can’t sell them at a loss anymore. Studies like Sosner et al. (2022) and Israelov & Lu (2022) show that while you might harvest about 13% in net capital losses in year one, that drops into the single digits quickly, and usually maxes out at a total of 30% of your starting portfolio over the lifetime of the strategy. That means that a $100,000 direct indexing account will only realize, at most, $30,000 in total tax losses.

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So, what do you do if you have gains you’d like to offset every year, like active trading or concentrated stock positions? What about outsized gains from selling property or exiting your business? Direct indexing just isn’t enough.

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What Makes Tax-Aware Long-Short So Different

Tax-Aware Long-Short (TALS) strategies take tax efficiency to a whole new level. Instead of just owning stocks that (hopefully) drop sometimes, TALS uses a mix of “long” (buy) and “short” (sell) positions — often powered by factor models like value, momentum, or quality.

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When you combine long and short positions in a smart way, you naturally generate losses as part of normal trading, not just deliberate tax trades. This means you can keep generating fresh losses year after year, regardless of what the market does.

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Research by Krasner & Sosner (2024) and Liberman et al. (2023) shows that well-designed TALS strategies can generate cumulative net capital losses (CNCL) of over 100% of your original capital within just three years. And this repeats consistently, year after year, without fading. Direct indexing, by comparison, typically stalls at ~30% over its entire lifetime.

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It’s Not Just About Taxes — It’s About Better Returns, Too

One of the coolest parts? TALS isn’t just about tax savings — it can deliver stronger pre-tax performance, too. Because TALS portfolios are built using factor models and active rebalancing, they chase alpha (excess returns above a benchmark) as they manage your tax profile.

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AQR’s 2023 simulations and Liberman’s studies found TALS can maintain information ratios around 0.4, net of trading and financing costs. Direct indexing doesn’t aim for pre-tax alpha — it just tries to mimic an index.

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Why Direct Indexing Has a Hard Ceiling

Direct indexing’s main drawbacks come down to structure:

• Once your stocks appreciate, you have fewer losses to harvest.
• If you want to de-risk or switch to another strategy, you may have to sell positions that trigger big capital gains.
• Owning so many individual stock positions interferes with your broader portfolio. For example, if you own AAPL in your portfolio, you can’t also trade it in your direct indexing strategy. This adds significant overhead, impacts performance, and introduces other systemic risks.
  
  

As research by Goldberg et al. (2022) shows, TALS is more flexible. Because it’s long-short, you can adjust risk levels, scale leverage, and transition your portfolio without needing to dump long-held stocks that would generate taxable gains.

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What a Real TALS Strategy Looks Like

A TALS portfolio usually has two parts:

1. A “core” index exposure to match or beat the market.
2. A “long-short overlay” driven by factor models.
   
   

The innovation is how gains are deferred. Rather than trying to harvest losses manually, TALS naturally sells losing positions while holding onto winners longer, pushing out taxes while still capturing upside.

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When TALS Works Best

• Offset short-term gains — If you’re an active trader and have frequent short-term capital gains, TALS can help offset that taxable income.
• Selling big positions — If you’re unwinding a concentrated stock position, selling property, or exiting a business, TALS can soften the tax hit. Tax losses can be carried forward indefinitely, so it’s best to start building your loss bank early.
• Tax flexibility over time — TALS portfolios tend to be extra valuable in volatile or down markets (like 2008) because they generate losses right when you need them.
• Integrated with multi-asset portfolios — TALS sleeves can be blended with other strategies to fine-tune your tax profile year after year.

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The Catch: Why TALS Hasn’t Been Mainstream (Yet)

So why isn’t everyone doing this? Traditional TALS strategies were complex and costly:

• You’d need to manage hundreds of stocks, margin accounts, and shorts.
• You’d need sophisticated tax-lot accounting and constant rebalancing.
• The minimums were high, often $1 million.
  
  

And it wasn’t always intuitive for retail investors used to simple, passive investing strategies.

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But times are changing. New technology, better models, and ETF-based frameworks (like alphaAI Capital’s) mean TALS can now be delivered in straightforward, transparent accounts. Custodians and platforms can handle the reporting, and advisors can easily explain how it works, bringing hedge-fund-level tax strategies to regular portfolios.

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Final Takeaway: The Next Evolution in Tax-Aware Investing

Direct indexing was a good step forward, but it has limits. TALS is proving to be the next evolution: more losses when you need them, smart gain deferral, real alpha potential, and more flexibility in dynamic markets.

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As tech and platforms catch up, this is no longer just for hedge funds and family offices. It’s becoming the new gold standard for tax-efficient investing.

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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. Goldberg, L., Linder, J., & Sosner, N. (2022). Tax-Efficient De-Risking of Long-Short Strategies. Journal of Investment Consulting.
6. AQR Capital Management. (2024). Our Research into Tax-Aware Long-Short Investing: Clarifying a Few Important Things. Retrieved from https://www.aqr.com