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Capital gains tax burden from rebalancing is a major concern for managing factor portfolios in taxable accounts. This article conducts 98 simulated backtests over a 10-year investment horizon spanning from 1964 to 2021 to investigate this issue under heuristic constraint-based algorithm. The authors find that value, quality, and safety buy-and-hold (BH) portfolios were able to generate significant pretax and after-tax alphas without any rebalancing. Based on this observation, they construct a composite factor using these three factors. The composite factor portfolios consistently outperformed the benchmark in more than 80% of the simulated backtests. Their performance can be further improved by allowing trades so long as they do not realize any net capital gains, such as tax-loss harvesting and selling factor losers only when they do not carry any capital gains. The results provide a simple and robust portfolio solution for a broad range of tax-conscious investors.
Chen et al. (Wed,) studied this question.