Beyond tax loss harvesting: why long-short strategies demand a harder look

The pitch for tax-aware long-short strategies has become familiar in advisor circles: generate losses to offset gains, defer taxes, and deliver better after-tax outcomes than a straight direct index.

But Ehren Stanhope, Chief Investment Strategist for Franklin Templeton's Canvas platform, thinks that framing has the conversation backward and that advisors who lead with the tax story may be setting their clients up for disappointment.

"We fundamentally believe long-short strategies can provide significant benefit," Stanhope said, "but the value driver should be the alpha model, not the tax benefits. What we're seeing today is a lot of conversations focused on the short book, and that conversation really needs to be inverted."

The tax lock problem no one wants to talk about

Before long-short even enters the picture, many advisors are quietly contending with a more immediate issue: the direct indexing portfolios they built for clients are sitting on significant embedded gains, and the harvesting opportunities that once justified the strategy have largely dried up.

Stanhope is candid about the dynamic. After an extended period of market appreciation, direct indexing "has provided a solution for advisors and clients to have greater control over when gains and losses are realized," he said. But as markets climb and losses are harvested, portfolios accumulate embedded gains and fewer positions remain below cost basis.

"This isn't a flaw in direct indexing," he said. "It's simply a consequence of long-term market appreciation."

The advisor concern is real, Stanhope acknowledges, but he pushes back on the idea that tax lock is a terminal condition. "Advisors tend to discuss it as though portfolios are static. In practice, tax loss harvesting is greatest within the first few years of funding; volatility, new contributions, and cash from dividends or dividend reinvestments can continue creating harvesting opportunities over time." His firm still views direct indexing as a durable, low-cost core equity allocation with built-in flexibility when markets pull back.

For advisors tracking the evolution of tax-efficient portfolio construction the long-short conversation is in many ways a response to direct indexing's maturity, not a replacement for it.

Who should - and shouldn't - consider long-short

Stanhope describes a specific client profile for tax-aware long-short. "We see the greatest interest among very high-net-worth and ultra-high-net-worth investors," he said. "Typically, these clients aren't coming to an advisor with a portfolio - they're coming with a balance sheet where every asset has an 'investment job' and a 'tax job.'"

A customized equity core in a long-short wrapper can serve clients preparing for a future liquidity event, managing a concentrated stock position, or looking to offset significant private market gains.

"For many of these clients, taxes have become important enough that they're influencing, but not driving, investment decisions," Stanhope said.

But he is equally clear about which clients should stay away. Those who are uncomfortable with an active manager underperforming - the short book can carry uncapped downside - should avoid the strategy. So should clients who have another advisor trading similar names in another account, since mixing long and short positions on the same stock across a household can result in a wash sale and disallow a loss outright. And clients without sizeable current or expected future gains to offset simply lack the tax profile that makes the complexity worth it.

"The biggest challenge is understanding everything the client owns," Stanhope said. "Affluent households often have taxable accounts, retirement assets, trusts, concentrated stock, real estate, and outside managers - all of which influence investment decisions."

Evaluating the manager, not just the strategy

For advisors who have identified the right client, Stanhope's framework for evaluating long-short managers is straightforward, but the sequencing is firm. Tax benefits come second.

"The first question is whether you believe in the manager," he said. "Look for managers with an established track record, a well-researched and proprietary - not licensed - alpha model, and proper risk controls."

Long-short strategies introduce leverage, higher costs - both investment and borrowing fees - and heightened risk and complexity. "Investment outcomes matter just as much as tax outcomes," he said.

Where the strategy does fit, Stanhope says it plays well alongside a concentrated stock position or an aging direct index account. The leverage effectively injects fresh cost basis into the portfolio.

And because the long-short position ideally becomes the household's main way of holding a given equity exposure, it requires clean household-level oversight to work correctly. "You don't want another account, or another advisor, holding a long position in the same name," he said.

Advisors interested in how personalized portfolio strategies are being implemented at scale will recognize that the execution challenge is precisely where technology plays a growing role.

The next frontier: coordinating the full financial life

Stanhope sees the long-short conversation as part of a broader shift in what personalization means in wealth management and where it is heading.

"The next generation of personalization will likely emerge at the intersection of alpha generation, tax efficiency, and technology," he said, "but the bigger shift is that personalization will become less about customizing a single portfolio and more about coordinating a client's full financial life."

Five years from now, he expects the firms that win in the high-net-worth market to be those that can make complexity feel simple for both the advisor and the client. Technology (including automation) AI-driven insights, and eventually broader access to emerging investment vehicles through tokenization, should make it easier to personalize at scale. "But the real value will still come from turning a complicated balance sheet into a clearer set of client outcomes," he said: "preparing for liquidity, managing taxes, generating income, diversifying risk, and aligning investments with what the client is actually trying to accomplish."

For advisors evaluating whether a long-short strategy belongs in their toolkit, Stanhope's framework offers a useful filter. The Canvas platform which now offers both long-short and traditional direct indexing in a single experience is one expression of where that evolution is headed. But the underlying message is platform-agnostic: start with the investment thesis, verify the household fits, then let the tax story follow.