Charles Schwab is introducing new limits for clients looking to deploy tax-efficient long-short strategies, becoming the latest brokerage to rein in a booming but potentially risky part of its business.
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The proportion of a Registered Investment Advisor’s total assets at Schwab that can be invested in so-called long-short separately managed accounts, or SMAs, can no longer exceed 30%, the firm told clients this week. New enrollments and incoming transfers to such accounts also face new minimums and leverage caps.
The changes, confirmed by a spokesperson, come a few months after Fidelity Investments stopped opening new long-short accounts amid the surging popularity of tax-aware investing. Pioneered by AQR Capital Management, these trades aim to generate capital losses to offset tax bills by going both long and short. While the use of leverage helps harvest losses more efficiently, it also raises risks, especially among retail investors less used to trading on margin.
“The operational reality is that sourcing shorts is more fragmented and challenging than many initially anticipated,” Brent Sullivan, who runs the popular Tax Alpha Insider blog, said in a message. “The custodian/brokers are adjusting to accommodate that reality.”
Fidelity is raising financing costs for long-short accounts starting from May for some clients, and is continuing to restrict the opening of new accounts, according to a person familiar with the matter who asked not to be identified as the information is private. Its pause meant Schwab became the main brokerage for new long-short accounts.
Schwab Chief Financial Officer Michael Verdeschi said on its earnings call the business helped drive a 16% increase in net interest revenue on a year-on-year basis last quarter. Clients’ margin loan balance stood at nearly $127 billion at the end of the period.
The brokerage this week told clients that all new enrollments and incoming transfers will be capped at 200% on long positions and 100% on short positions, or 200%/100%.
That could be a restraint on the more aggressive versions of tax-aware long-short strategies, which are pitched with leverage of as much as 300%/200%. The higher levels are often used to rapidly generate losses that can then offset taxes from the profitable sale of a private business or concentrated stock position.
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From now on, new Schwab accounts in a traditional Reg T margin account, which is typically used for 130%/30% and 145%/45% strategies, will have a $1 million minimum. A $3 million minimum will be imposed for portfolio margin accounts, which are typically for leverage levels of 150%/50% and higher.
“We are committed to Long/Short SMAs on Schwab’s platform,” a spokesperson said in an email. “The changes we have recently shared with our participating RIA clients are designed to ensure Long/Short SMAs on Schwab’s platform grow responsibly over the long term. Schwab has the scale, the balance sheet, and the expertise to support this offer and will continue to meet the needs of RIAs and their clients.”
