3D Active Tax Management

Optimizing for Impact, Tracking Error, and Taxes

Unlock the full white paper and take control of your 3D tax strategy today. Here are some key insights you’ll find:

Values-Alignment

Ethic’s 3D Active Tax Management enhances after-tax savings while aligning with clients’ risk, impact, and mission goals.

Personalization

Technology facilitates daily tax-loss harvesting, automated transitions, and tax optimization while maximizing values-aligned goals.

Case Studies

Explore how 3D Active Tax Management drives real impact with actionable examples.

A new approach to active
tax management

Ethic’s 3D Active Tax Management aligns clients’ holistic values-aligned goals by balancing the tradeoffs between three priorities:

Impact

Aligning holdings with impact goals through exclusion and inclusion strategies.

Returns

Minimizing tax impact to enhance after-tax returns.

Risks

Managing risk relative to a benchmark.

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Frequently asked questions

What is the relationship between 3D Active Tax Management and values-aligned investing?

Values-Aligned Investing (VAI) places client values at the center of portfolio construction by managing the holistic interplay between removing specific holdings (divestment) and/or proactively overweighting positions (investment) to align with impact goals, assessing tracking error (portfolio risk versus a benchmark), and taxes.

‍3D Active Tax Management is tax management for VAI. It seeks to minimize the burden of taxes on portfolio growth while equally considering tracking error and the desire for impact.

How does Ethic’s 3D Active Tax Management approach differ from competitors and emerging direct indexing providers?

In traditional portfolio management, impact, tracking error, and taxes often come into conflict with each other — divesting and investing to make an impact have been viewed as constraints, rather than actions that can create optimized portfolios that align with investors’ unique values.

With 3D Active Tax management, Ethic weighs the tradeoffs between these priorities before every portfolio action to optimize a values-aligned investment (VAI) strategy.

What is tax-loss harvesting, and how does it benefit investors?

3D Active Tax Management employs tax-loss harvesting (TLH), a strategy where Ethic sells assets trading below their cost basis to "harvest" losses. These losses can offset capital gains and lower an investor’s tax liability. As part of the investment process, TLH can enhance after-tax returns, allowing investors to maintain greater capital in their VAI portfolios — capital that can continue to be invested to drive impact.

Is tax-loss harvesting appropriate for all investors?

Tax-loss harvesting (TLH) can provide tax benefits for many investors, particularly if they are in a high tax bracket or have significant realized gains. These gains can be used to offset their capital gains and reduce tax liability.

How do market factors (including volatility) influence tax-loss harvesting opportunities?

Market factors may impact the amount of losses available for Ethic to capture, including, but not limited to general trends in market movements and general market volatility or price trends and volatility in specific securities

Can tax-loss harvesting be applied to all types of investments within a portfolio?

Tax-loss harvesting (TLH) can only be applied to taxable investment accounts. It can't be used with tax-advantaged accounts that already have tax deferral benefits, such as IRAs or 401(k)s.

What does 3D Active Tax Management look like on an ongoing basis?

Before executing any portfolio action, including transitioning new portfolios into Ethic’s ecosystem, three key priorities are evaluated:

1. Impact (through divestment and investment)
2. Tracking error (portfolio risk versus a benchmark)
3. Taxes

The Ethic Platform (the “Platform”) is designed to help investment teams and wealth advisors navigate these tradeoffs to reach values alignment. The Platform monitors portfolios daily, identifying trade opportunities to advance an investor’s impact goals while minimizing taxes and staying within their risk tolerance levels. Key metrics are used to quantify these objectives, which are run through an automated process to ensure portfolios remain aligned with investors’ VAI objectives.

How does Ethic handle concentrated positions?

Many clients come to Ethic with existing portfolios that have embedded gains and, in many instances, concentrated positions. Liquidating these assets and starting over could generate a large tax bill and introduce additional tracking error.

3D Active Tax Management enables us to gradually transition a client’s positions over time, identifying any overlap in holdings and determining the amount of taxable gains the client can reasonably absorb without deviating too far from benchmark exposure. On an ongoing basis, we can optimize to manage the client’s tax liability and tracking error — all while incorporating the most up to date financial and sustainability data—to help the client achieve greater impact and after-tax returns.

How frequently should tax-loss harvesting be conducted for optimal results?

The Ethic Platform monitors portfolios daily for tax-loss harvesting (TLH) opportunities. Research supports the effectiveness of this strategy: regular TLH can generate approximately 100 basis points of tax savings (also known as “tax alpha”) annually, making it a powerful tool for enhancing portfolio performance.

What are the potential risks associated with tax-loss harvesting?

The ability to harvest losses is limited by a variety of factors, including, but not limited to:

1. Different account configuration selections may limit the universe of securities the account could hold and therefore limit the losses available for harvesting, or could otherwise limit the effectiveness of a tax-loss harvesting strategy. Such account configuration selections include, but are not limited to: tracking error budgets, sustainability preferences, tax sensitivity and gains budgets, rebalance frequency, benchmark selection, restrictions on uses of American Depository Receipts, or any other portfolio restriction or election.

2. Different account actions initiated by an advisor client may limit the ability to trade or otherwise effectively harvest losses. Such account actions include, but are not limited to: the timing of wash sale windows, other pending trading requests such as requests for partial account liquidation, trading halts, ticker restrictions, the timing and type of initial funding for an account such as accounts funded with highly appreciated securities, or the timing and type of cash flows throughout the life of the account.

The above list is not exhaustive — additional factors may limit the ability to harvest losses.

Can tax-loss harvesting be beneficial in both rising and falling markets?

Both rising and falling markets can present opportunities for generating potential tax savings through tax-loss harvesting.

What is the IRS wash-sale rule, and how can it impact tax-loss harvesting strategies?

The IRS wash sale rule says that once a security has been sold at a tax loss, "substantially identical" securities cannot be purchased within 30 days before or after the tax-loss sale, a 61-day window.

After selling a losing position, Ethic replaces it with another stock already in the portfolio or a similar security with equivalent risk characteristics.