Toward Tax Efficient Low Volatility Investing

Abstract

This paper reevaluates the low volatility investing strategies and, in particular, their tax efficiency. Low volatility strategies intend to help investors achieve market-like equity returns, but with less risk than that of the broader market. Among the low volatility strategies, those with lower volatility carry lower returns, but incur higher turnover and tax burdens. Explicit tax management can greatly improve the strategy performance. Tax management, nevertheless, is no easy task in practice due to the burdensome record keeping. This paper proposes two sets of tax managed low volatility investing strategies that require different amount of record keeping. Both strategies can significantly improve the after-tax strategy returns, while maintaining the compelling risk and pre-tax return profile. Specifically, accounting for net taxable gains alone can harvest most tax alphas, and accounting for the timing of tax lots accurately in addition can further improve the strategy performance.