This is information rather than tax advice. Anyone holding these strategies should review their position with qualified counsel.
- Charles Schwab is preparing its own tax-aware long-short products, with chief executive Rick Wurster telling analysts the firm is examining an extended version of its direct-indexing capability on long-short accounts. He said more direct control delivers balance sheet and operational efficiencies and makes the strategies manageable over the longer term.
- The announcement follows restrictions in the opposite direction. In early September Schwab told clients they would need $10 million of assets to fund some long-short separately managed accounts, up from $1 million, and said it would not enrol new clients or accept new funds in portfolio margin accounts, which use greater leverage.
- Regulators have put the industry on notice. The IRS issued warnings last month saying it plans to publish guidance and may take steps to bar certain trades money managers use to harvest losses and reduce tax bills, including on ordinary income. Among them is a long-short strategy popularised by AQR, the world’s largest hedge fund.
- Large institutions are responding to the same signal in opposite ways. Goldman Sachs is paying up to $2.25 billion for Neos to acquire exposure to tax-optimised products, while Schwab is restricting client access to third-party versions and insourcing.
What Happened?
Schwab provides custody for these strategies, which is why its platform limits affect access regardless of who manages the money. Bloomberg has separately reported that Schwab and Fidelity have turned down billions from the strategy, and that the approach has been marketed well beyond its original ultra-wealthy audience.
Why It Matters?
The tenfold increase in minimums is the part advisers need to act on. Clients between $1 million and $10 million who could previously access these strategies on the Schwab platform are now outside the threshold for new accounts, and that changed in September without much attention. Anyone planning to implement a tax-aware long-short strategy through Schwab should confirm current eligibility before building a plan around it. The closure of portfolio margin accounts to new money matters for the same reason, since shorting requires margin and the leverage is integral to how these strategies work. Building a proprietary version while restricting third-party access is a combination worth examining rather than accepting at face value. The stated rationale, operational and balance sheet efficiency, is plausible for a custodian carrying the risk of leveraged client positions. The competitive effect is that clients wanting the strategy on this platform will increasingly find Schwab’s own product as the available route. Whether that is prudent risk management or commercial positioning is not something an earnings call answers, and both motives can be present at once. The divergence between large firms is the useful signal. Goldman is acquiring a business built on an aggressive reading of the tax code weeks after the IRS warned it may bar some of these trades, while Schwab is reducing access to the category and keeping what remains in-house. Two sophisticated institutions reading the same regulatory warning have reached opposite conclusions about how much exposure to hold, and clients are entitled to weigh that when deciding how much of their own plan depends on these structures persisting. The leverage question deserves attention too. If the IRS restricts the trades and custodians simultaneously withdraw margin capacity, positions would need to unwind under both constraints at once, which is rarely orderly.
What Next?
The IRS guidance flagged last month is the determining event, and its scope will show whether these strategies survive in modified form or not. Watch whether other custodians follow Schwab in raising minimums, since platform access matters more than manager availability. Schwab has not given a timeline for its own product, and the terms it offers will indicate how much of the strategy it believes will remain permissible. For clients currently in these structures, understanding the remaining cost basis and what happens if the tax character of the trades changes is the practical preparation.
Affected Tickers and Coins: SCHW, GS, BLK, MS
Source: Bloomberg
