The tax-focused hedge fund craze taking over Wall Street
New breed of products from firms such as AQR and Quantinno has soared in popularity, raising regulatory concerns
Hedge funds have added $90bn in assets from a strategy that slashes wealthy investors’ tax bills since the start of last year, making the controversial area one of the fastest-growing parts of the industry.
AQR Capital Management and Quantinno Capital Management are among the hedge funds behind the surging popularity of a new wave of tax-loss harvesting strategies, which aim to deliver both market-beating returns and gains derived from lowering investors’ tax liabilities — dubbed “tax alpha”.
Tax-loss harvesting is a longstanding practice where securities are sold at a loss to offset gains elsewhere in a portfolio. Firms such as Morgan Stanley-owned Parametric have long specialised in a long-only version, which involves strategically selling lossmaking positions.
But the $207bn hedge fund AQR and Quantinno, which was set up by a group of former AQR traders in 2018, have pioneered an approach that uses leverage and algorithmic trading to buy and short securities at scale, and to systematically realise losses on positions.
“The magnitude of losses you’re getting is larger, and they’re more stable and consistent,” said Shang Chou, co-founder of the multi-family office Dishmi Capital. “This works in up and down markets.”
AQR said that the “primary draw for investors” should be the returns from its strategies — the “pre-tax alpha”, or market-beating performance — before any tax benefits.
“Without pre-tax alpha, these strategies are not worth the fees,” AQR said. “This business is the culmination of our longstanding focus — producing attractive investment returns while helping taxable investors keep more of what they earn.”
But the surge of new investments has raised concerns elsewhere on Wall Street that the strategy has grown too quickly.
Fidelity Management halted new investments in long-short separately managed accounts in February, according to people familiar with the matter.
AQR and Quantinno run hedge funds where investors’ capital is commingled, as well as tax-aware separately managed accounts for investors, which Quantinno founder Hoon Kim described as “mini hedge funds”.
Critics also argue the strategies’ widespread use of leverage and short selling makes them riskier than they may appear, with losses potentially compounded by any stock market crash.
“The problem with it is it comes with a cost that people don’t understand or appreciate,” said one multi-family office executive. “It’s compounded when you do that with leverage.”
They added that investors often piled in at the wrong time, with the “best time” to invest in the strategy being after the stock market had already suffered big losses.
AQR and Quantinno differ from earlier iterations of tax-aware investing strategies by seeking to generate income losses as well as capital ones through the use of swaps and other expenses.
That allows investors potentially to offset regular income taxes as well as reducing their capital gains, according to people familiar with the matter. Though investors must pay taxes when they liquidate the funds, they are able to defer that payment indefinitely if they hold the investments until death.
Pat Nerney of wealth advisory group Dynasty Financial Partners said the new hedge fund strategies put previous approaches “on jet fuel”.
The tax-aware strategies have helped AQR to add $47bn since March last year and Quantinno $39bn since January 2025, according to investment presentations seen by the FT and people familiar with the figures. That compares with growth in the wider hedge fund industry of about $628bn last year, according to data provider HFR.
Almost a third of AQR’s total assets were held in its tax-aware funds by the end of December.
“It’s the hottest product in Greenwich,” said one person who works on Wall Street of tax-aware funds.
Fathers at a recent local sports game were fixated on AQR’s Delphi Plus fund, which specialises in ordinary income losses, the person added. “Everyone’s piling into them now.”
Quantitative funds including Two Sigma and WorldQuant Millennium Advisors have launched similar offerings, according to people familiar with the matter.
Two Sigma’s fund, Two Sigma Beacon, has been offered to employees since 2022 but was opened up more widely at the end of last year and now has about $950mn under management, according to an investor presentation seen by the FT and a person familiar with the matter.
Quantinno founder Kim declined to estimate how much the firm had saved clients in taxes. But he acknowledged that the funds, which allow investors to defer the payment of taxes for years, had soared in popularity in recent months.
“Once the word started spreading, it spread very quickly,” he said.
Demand for the strategies has led to higher minimum investment thresholds.
JPMorgan Chase’s private bank now requires clients to invest at least $25mn for one strategy with a 1.1 per cent management fee, and $50mn with a 0.65 per cent fee for another, according to an internal document seen by the FT.
Bank of America’s Merrill increased the minimum investment for another AQR product to $1mn from $350,000 earlier this year, according to people familiar with the matter. The bank has more than $600mn in client assets with the fund, the people added.
JPMorgan and BofA declined to comment.
Some investors and advisers also warned of potential regulatory scrutiny. “The deepest and most fundamental risk is that the IRS catches wind of this,” said one financial adviser.
Tax lawyers and investors said the strategies could become a target if Democrats win the White House in 2028.
Existing laws already prevent some extreme forms of tax-loss harvesting, such as the 1921 “wash-sale” rule, which bars investors from selling and buying identical securities within 30 days. But other grey areas remain.
“Democrats will both have the interest and the financial incentive to raise some revenue and shift the pendulum back” on tax loopholes, said Steve Rosenthal, a former senior fellow at the Tax Policy Center.
“If the Democrats re-take the executive branch, they will step up enforcement — and aggressive enforcement at that — against sophisticated tax planning by the rich. So then the question is: how quickly could they act?”
AQR noted the risk in the small print of investor materials, warning that tax benefits “may be less than expected”, including in the event of a successful challenge by the IRS. “Penalties may apply,” it added.