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- Charles Schwab reported quarterly earnings this week that included margin loan balances increasing 14% quarter-over-quarter to $187.9 billion, including $60.7 billion related to long/short strategies.
- Those “tax aware” strategies have been booming in the accounts of the wealthy, by one estimate recently provided to CNBC from as little as $2 billion in 2022 to $170 billion this year.
- Schwab CEO Rick Wurster said on the broker’s earnings call that the brokerage company plans to launch its own version of this strategy. “We are thrilled about that, working on it,” he said.
watch nowVIDEO07:05Charles Schwab CEO Rick Wurster on Q3 results: A record quarter in serving clientsSquawk Box
When Charles Schwab released its quarterly earnings on Thursday, it wasn’t the quarterly earnings per share print in the numbers that caught the attention of those who manage money for wealthy stock investors — it was a $60.7 billion figure. That was reported in a detail about margin loan balances which increased 14% quarter-over-quarter to $187.9 billion, including a whopping $60.7 billion related to what are known as “tax-aware” long/short strategies used by many registered investment advisors.
These strategies have been booming as a way for the wealthy to super-charge tax-loss harvesting approaches to stock gains and losses. According to one estimated provided by Tax Alpha Insider to CNBC in September, total assets in TALS surged to more than $170 billion this year from $2 billion in 2022.
Now Schwab is planning to take a bigger piece of that action. On the earnings call, Schwab CEO Rick Wurster said in response to a question from UBS analyst Mike Brown that the broker will launch its own version of the tax-aware long-short strategy.
“Obviously, the tax advantage long/short products have been a meaningful driver of client demand and asset gathering across the industry. There is an increasing number of funds coming to market, and so given Schwab’s positioning and client interest in the category, do you see an opportunity to launch a proprietary solution?” Brown asked.
What Schwab’s CEO said
“I do expect us to have an offering,” Wurster said. “We already have a great direct indexing capability today that has had wonderful performance in terms of tax alpha and delivering for clients, and I expect us to be able to deliver an extended version of that on long/short. … Certainly another way we can deliver monetization, but more importantly, it is a way we can deliver sustainable long/short strategies to our clients in a way that is operationally and financially manageable over the longer term,” Wurster said.
With the stock market posting big gains for multiple years in a row, the wealthy are looking for more ways to shield capital gains from taxes, according to a recent report from CNBC Inside Wealth’s Robert Frank. The situation is similar for business owners cashing out and executives with hefty stock compensation packages, and for employees at firms that have gone public in recent years. For the brokers and investment advisors, the products offer relatively high fees and attract new wealthy clients.
How these capital gains tax strategies work
Wealthy investors already use direct indexing strategies on platforms including Schwab to pair up stock gains and losses in a tax efficient way. The issue that wealthy investors run into with standard tax-loss harvesting is that fewer and fewer losses become available to harvest over time, according to an overview of TALS from advisor research platform Kitces. “Because on average, the market tends to rise, and so in a diversified portfolio most positions will eventually rise far enough above their cost basis that even subsequent downturns don’t result in taxable losses, while for positions that do continue to decline there’s only a finite amount of losses they can actually generate (because their market value – and cost basis – can only go down to zero),” it wrote.
Tax-aware long-short strategies get around this by adding leverage on both the long and short side of an existing portfolio, with the investor buying more positions and increasing the number of potential losses to harvest. That allows the portfolio to remain “economically neutral … And because short positions can theoretically generate an infinite amount of losses (since they decline when markets rise), TALS portfolios are less likely to run out of losses to harvest over time than standard long-only portfolios,” Kitces noted.
Questions remain, from access to tax risks
Brent Sullivan of Tax Alpha Insider noted in a post on X on Thursday that advisors will have many questions about the Schwab products, which he noted should not be referred to as “funds” — UBS analyst Brown used that terminology in his question. Sullivan wrote that it is reasonable to speculate that a Schwab product could “meaningfully lower” the assets under management minimum requirement typical on these products, but it is also an open question as to whether the products will only be available to Schwab advisers and only on Schwab’s platform.
Wurster provided few details, and no timeline for a launch. “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 been taking a more aggressive stance on tax avoidance strategies and some though not all “tax alpha” strategies of the wealthy, with Treasury Secretary Scott Bessent and the IRS recently issuing a notice over the use of sophisticated ETF strategies to shield capital gains from taxation. The notice also expressed interest in “tax-aware” strategies typically structured as partnerships or separately managed accounts, but according to an analysis from law firm Ropes & Gray, it also made clear that “tax-aware” itself is not a cause for concern and year-end tax loss harvesting is a well-established practice.
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