Understandable Artificial Intelligence

Overview

EDS was given a long/short strategy by a U.S. endowment

The strategy: Passive long and active short with the goal to harvest tax losses

The goal: evaluate the strategy and whether it makes sense to pursue

Introduction

A.I. and Big Data offer substantial benefits to construction of tax efficient portfolios

Complex and unique circumstances
- Each client is different, no 'canned' solutions
- Our tools allow for a true 'Portfolio Manufacturing' approach which is in line with CFA best practices
Technology Problem
- Tracking the unique circumstances of investors
- Finding the individualized impact of investment decisions
Investment Problem
- Identifying the investments that address client needs
- Allocating among those opportunities in a way that 'gets the most' from each

Quantifying Tax Drag

Our tools are designed to use detailed information

For this example we shall highlight only a few broad examples

Municipal Bonds
- These are generally tax-exempt at the federal level but in many cases are effectively taxable due to Alternative Minimum Tax (AMT)

Capital Gains vs. Investment Income
- Which type is more efficient will heavily depend on circumstance
- For this example, we assume both income and capital growth are priorities

Importance of turnover
- Turnover causes gains to be realised and taxable
- High turnover and some vehicles can lead to unexpected gains

Quantifying Tax Drag (cont)

Tax loss harvesting
- When investments realise losses, they can be used to offset gains
- This is a valuable tax efficient strategy
- Tax loss harvesting can be carried out through a separately managed account (SMA) or within your own investment strategy
Dividend Tax Drag
- Although often thought of as having a tax drag, this type of income is normally taxed at the lower capital gains rate

We Find No Tax/Return Relationship

This indicated to us that focusing on this as a goal tended to hurt more in returns than was gained in tax benefit

*Data from EDS, Prospecta Trust, & Bloomberg, courtesy of London Business School

Tax And Other Relationships

Controlling for other factors this remains true, indicating a higher after-tax return is possible with focus on other areas

*Data from EDS, Prospecta Trust, & Bloomberg, courtesy of London Business School

Conclusion On Tax

We split this many ways, but indications remain the same
- When balancing all driving factors we find that focusing on tax loss harvesting is more likely to detract from the total after-tax return
Our tool can help show these trade-offs
- A tool like ours will make balancing the risk/reward across many forms, a more informed process
- This in turn could lead to additional insights

Disclaimers

Please remember that past performance may not be indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product made reference to directly or indirectly in this presentation, will be profitable, equal any corresponding indicated historical performance level(s), or be suitable for an individual's portfolio.

Our projections are based on current market conditions which can vary over the coming months and weeks. Additionally, our projections are based on historical market behavior which may vary unexpectedly. Using Machine Learning, our tool should adjust to new market fluctuations but we might not be able to avoid short term volatility.

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info@EconomicDataSciences.com

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