Tobias Moskowitz, Fama Family Professor of Finance
Summary: We examine the after-tax performance, tax exposure, and tax efficiency of size, value, growth, and momentum equity styles. On an after-tax basis, value and momentum outperform, and growth underperforms, the market. Decomposing the tax exposure of each style, we find that turnover is a misleading indicator of tax efficiency. Momentum, despite having more than five times the turnover of value, has the same tax rate as value, because momentum generates substantial short-term losses while value has high dividend income. In addition, tax optimization through capital gain and loss realization incurs less tracking error than avoiding dividend income. Hence, momentum, whose tax exposure is primarily driven by capital gains, while value and growth's taxes are more sensitive to dividends, is the only style that allows significant tax reduction without incurring significant style drift. The differential effects of taxes across equity styles are magnified within a broader asset allocation framework and in down markets.