- Is it possible for lower risk to lead to higher returns?
- How can the implementation of quality-based investment strategies also lead to large tax efficiencies?
- What if investing in high-quality stocks could yield higher returns with less risk while also being extremely tax-efficient?
We believe in a globally diversified approach with some exposure to each of the Core Four economic environments while pursuing opportunistic investments and extreme tax efficiency. Within our framework, we execute investments in strategies that favor high quality companies, which have historically outperformed. In addition, we are doing so in tax-efficient strategies that can further enhance after-tax performance.
The Quality Tax-Efficient Edge
Tax aware hedge funds can significantly enhance your investment returns and in some cases, reduce your taxable income from any source. These strategies combine high quality long-short equity with systematic quantitative strategies to generate investment returns with relatively low correlation to the “stock market.”Furthermore, these strategies utilize the tax code’s favorable tax treatment of certain assets, which leads to material tax saving benefits.
High-Quality and Lower-Risk Stocks
Our preferred tax aware hedge fund favors high-quality stocks, which are defined by high profitability, stable earnings, and low debt levels. This focus on quality ensures that the strategy targets companies with resilient cash flows and strong fundamentals, enhancing the potential for superior long-term performance.
Quality stocks tend to perform well during bear markets, often declining less than the broader market. This resilience is crucial, as it mitigates losses during downturns. While quality lags in strong up markets, overall, quality has compounded at a higher rate over time with less stress and volatility. High-quality companies can weather economic challenges better due to their robust financial health and disciplined capital management.
The chart on the left below shows the relative performance of high quality and high quality with value for all periods from 1928-2022. The chart on the right displays performance during bear market periods when the broader market experienced at least a 20% decline from any peak (1928-2022).
Source: GMO
Unlike conventional finance theory and the bond market, quality stock performance does not follow the trade-off between volatility and returns in that high quality stocks have exhibited lower volatility, yet higher returns. The plots below exhibit these relationships.
Source: GMO, Bond data from 1995, Stock data from 1988, quality stocks defined as low debt, high profits, low profit volatility and junk stocks the reverse
Quantitative Systematic Trend for Diversification & Tax Benefits
High quality stocks can be augmented with strategies that identify assets with positive price trends and favorable macroeconomic fundamentals. This approach complements quality stocks and tends to perform well when broader markets are volatile, adding a layer of diversification and stability to the portfolio.
Quantitative strategies also utilize various financial securities that have more favorable tax treatment, including the realization of ordinary losses and short-term capital losses. These strategies create tax benefits that lead to higher after-tax returns and under certain circumstances, a reduction in ordinary income from any source.
At Essential Partners, we understand the importance of diversification to the Core Four economic environments while also investing in high quality, tax saving strategies. We believe this combination not only lowers risk but leads to higher investment returns on an after-tax basis.
For details, email us at info@essentialp.com, call 213-878-0075 or visit www.essentialp.com/contact-us/.
This presentation contains general information that is not suitable for everyone. This is not tax advice and you must consult a CPA. The information contained herein should not be construed as personalized investment advice. There is no guarantee that the views and opinions expressed in this presentation will come to pass. Investing in the stock market involves gains and losses and may not be suitable for all investors. Information presented herein is subject to change without notice and should not be considered as a solicitation to buy or sell any security. Essential Partners, LLC does not offer legal or tax advice. Please consult the appropriate professional regarding your individual circumstance.