Wes Gray: Optimizing for After-Tax Returns

s with Wesley Gray - November: 2025

[00:00:00] Wes Gray: So you would basically close down your, you'd have to do this in the most tax efficient way possible, which wouldn't be too hard. You'd basically close down all your shorts, close down all your longs that weren't creating a tax problem, and then you'd be left with a basket of these really low basis kind of like left tail, you know, 100X type stocks, because that's where all your tax problem is. And then you could just hold onto that obviously. Or if you wanted to, you could then 351 that. Because now you're 351 diversified, and then you could go become S&P again if you wanted.

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[00:00:46] Wes Gray: Good man. Pleasure to be here. Good to catch up. It's been a while. I can't remember when was the last time I was on your guys' pod? Maybe a year ago. a year and a half ago.

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[00:01:07] Wes Gray: Yeah. The last March for the Fallen, probably. That's, I can't even remember, man, that might have been three years ago.

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[00:01:16] Wes Gray: Yeah. We live in the Caribbean together. We should be able to figure this out, I imagine. But, logistics are challenging, I guess the, this whole thing called an ocean in between us.

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[00:01:30] Wes Gray: We'll figure it out and…

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[00:01:41] Wes Gray: Yeah, I'm running both businesses now, the Alpha Architect biz and the ETF Architect biz, which is the infrastructure side. I drew the short straw, so now I kind of herd the cats in both of them, which is…

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[00:02:05] Wes Gray: I'm not that, yeah, I'm not that efficient, unfortunately. I probably need to get rid of one of my full-time jobs here at this point. But yes, I am pretty dang efficient, so I do lead a pretty normal, balanced life, despite the task at hand. I don't want to do anymore because I like hanging out with my kids and everything, like I'm sure everybody does. It's also luxury of living down here where I live. I think it's probably similar to you guys. I live in like a golf cart community, so you know, my commute to school, the kid's school is, I don't know, two minute golf cart ride commute to, working out is open my door. It's just every, I don't have frictional time issues.

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[00:02:59] Wes Gray: Nope. Exactly. Yeah, if you do the math on, that's what, an hour and a half of what, “wasted time”. If you just got magically, hey, here's an hour and a half, maybe even two hours of day, what would you do with that? Now you could do all the essentials that you probably needed to do that you didn't have time for, but like a, two hour of frictional cost and just busy is not a great use of time, generally

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[00:03:36] Wes Gray: Yeah, no, no exactly. We're obviously privileged up to be able to do that.

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[00:05:09] Wes Gray: Yeah, so, actually that is, that's how we started. So tax behind the scenes has always been our DNA, from the very beginning, that's why we got an ETF business. It's not like a very public thing, but essentially, going way back to the start, our, like this was whatever, 15, 16 years ago, our first project was managing an SMA doing factor investing with tax efficiency.

ing and then, and this was in: 2010

And so then we immediately transitioned into the ETF structure for predominantly tax efficiency reasons. And then we, and we also started a business in a 1042 rollover, which is named after Section 1042. We started that probably, I don't know, 10 years ago. And that's a huge business we run in doing tax rollovers in the ESOP space. So obviously after the, once the active ETF rule came about in 2019, obviously we were familiar with the tax deferral or the tax structuring like 351 and 368, all this stuff.

It's just, the problem is until the ETF world was able to say hey, active ETFs get the same tax capabilities as index based ETFs with respect to like customs and everything, it's, there's not really much to see here. And then, but obviously once that happened, we immediately pivoted, and that's why we'd lead and have probably done more deals than 351 and every other operator combined, because we've been way ahead of this curve, and all we do behind the scenes is tax structuring. So, yeah, it's not, it's a little known history, but the reality is, we've always been tax first, how do we figure that problem out, because all of our clients are taxable, and so it doesn't really matter how much alpha you got, if 50% of it you’ve got to give back to the government.

We got to solve that problem first, and then we'll figure out how to deliver whatever alpha or strategy or whatever we're doing. So weirdly, that's something we've, that we're actually the leaders in that I would say in many respects, which is why I'm so familiar with literally every single tax structure and idea and concept that's available at this point.

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[00:07:58] Wes Gray: … live in Puerto Rico.

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[00:08:01] Wes Gray: Yeah, exactly. and we've done all these things like, yeah.

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[00:08:11] Wes Gray: Yep. So, basically Section 351 is a situation where, basically what the tax code says is, hey, if you want to contribute property to set up a new C Corporation, you can do so in a tax free manner. So, generally speaking, if an operating company, let's say, and Bob our tax guy, he always uses like the shoe store analogy.

So let's say I make pumps, and you make Nike's, and we're like, geez, that we'd like to set up a different business to offer both of these. Hey Adam, let's set up a new business. You contribute your Nike's, I'll contribute the pumps and we'll have this beautiful conglomerate. We'll add all kinds of value.

And 351 says, great. You guys can do that without taking a tax hit, right? Because if we had to pay a tax on the property that we shifted into the new business, it would, it basically destroy capital formation. Which is why 351 came into the code 60, 70 years ago. And then of course you over time, people get smart, they add different Treasury regs because one of the nuances of 351, they say, that's awesome.

You get tax retreatment, you contribute property, no problem. But then, people start thinking hard and they're like, what happens if I contribute property to a C Corp that elects to be an RIC, a mutual fund or an ETF? And they're like, wait a second. When you're a C but you elect to be a RIC, you guys are avoiding our double taxation thing. We got to hammer down on you guys.

So, within 351, with respect to funding a RIC, like an ETF, there's additional rules, and they have these diversification requirements where, it's basically like for 351, you can't just take your 50 million in Tesla, turn it into an ETF tax free, and then turn it into S&P 500. That ain't going to fly. So, the rules with 351, with respect to ETF, is you have to do diversified contributions, because the IRS basically says, listen, if you're already diversified and you're just going to go to diversified. Fine, you guys can be also tax free.

But, as the definition of diversification in the minds of a tax attorney, versus like you guys, like a financial engineer. They're very different, right? so to qualify for diversification from a tax perspective, the only rules are, you can't have more than 25% in one security, which, that's not very diversified to most people, but to them it is. Fine we'll take the loss. And then the other one is that the top five contributed securities can't be more than 50% of your total. So essentially like an 11 stock equal-weight would work, right, because you want to trigger both those. But, so that's, the thing about 351 is, you have to contribute diversified property. And they're, and obviously that's a strict hard and fast mechanism.

And, obviously that's, but most people have enough diversification. Their problem is they're under-diversified, or they just got all kinds of portfolio complexities, or over, it's just basically they usually have a pain in the ass, but they can't do anything for tax reasons. And so 351 is basically an opportunity to help them get more efficient, clean up their portfolios, get better diversification, lower cost, et cetera, which is why it's white hot right now.

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[00:12:20] Wes Gray: Yes. Or they could do a lot of things, but yes, what they're basically doing is eating tons of uncompensated risk for no reason ,outside of I don't want to pay a huge tax bill. And, that is literally the intent of the law effectively, right? Like, how do we help people? Like how do we have more efficient capital formation? And like from a societal perspective, you don't want people bearing the risk of all in on a single stock, generally speaking, because then it's just, the cost of capital is going to explode.

So all these tools, I think, from a macro perspective make a ton of sense, because they keep prices more efficient, allow capital to move efficiently and become properly diversified, et cetera. and obviously, there's always got to be rules, which we're going to follow. But that's, at a high level, that's what basically 351 is offering people. There's, just like any rules, you, there's a bunch of what about this, what about that? And you got to follow the rules. But generally speaking it's a huge opportunity for value creation.

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[00:13:57] Wes Gray: Yeah, so this is the beauty of a 351 deal is there's no restrictions, right? It's, and I'll juxtapose that against exchange funds and other solutions out there. So in 351, what the, all this is, this is just a bona fide ETF, like any other ETF after it launches, right?

The only difference is the seating mechanism. And luckily, in 60: 11, there's actually also language which is very important for these deals, where it specifically states that new ETFs can also, besides a broker/dealer providing seed capital, they can also be seeded with property. Obviously that's important because if the SEC doesn't like this, then who cares what the tax rules say, because we need to be able to actually do it.

Thank God in 60: 11 it makes it very clear that you can seed an ETF with property and that, and so then here, in comes 351. But once, to answer your first question, once you launch this thing, it's just an ETF like any other ETF, and anyone on the street with a Schwab account can go click the button.

And what, but now let's get back to the seating mechanism. So on the seating mechanism, if you have a diversified 351 contribution, you're going to basically get a carryover basis. So it's not a step up, it's a deferral, right? So if you had zero basis in a $100 M of property, you're just going to have a zero basis of a $100 M of ETF shares, right? So you're not becoming better off just from the transaction. Obviously, it's just a change from your current status to like ETF and, as the ETF is just a more efficient way to manage capital, generally speaking. So why wouldn't you want to be in that wrapper?

But there's no, if you wanted to do the deal and then for whatever reason you're like, geez, I need $100 M, guess what? If you sell your shares, you're going to have to pay the tax. It's, so there's no difference there. But it does provide an opportunity, like I was saying, if you want to clean up your book, get better, diversify it or do whatever you want, it's, once it's in the ETF structure, there's obviously just a lot more flexibility, whereas you can't do anything if you're just holding your Nvidia and Microsoft. You're stuck. You're not going to do anything.

And so with the ETF structure, over time, depending on investment mandate, obviously you can maneuver because you have an active management mandate. Like, in theory you could contribute into a 351 deal, and if the asset manager's great, I want to be long S&P, just joking, I think Trump's crazy or whatever, I want to go to cash, you could do that, right? And that would be tax free because you'd use a custom to do, so I mean it, as long as you're always making decisions based on economic substance and like the investment merit at that time, you could use your imagination, but you could do a lot of stuff with 351.

You got to be careful with like intent, and like premeditation. But, if there's bona fide economic investment reasons to do something, you can do it generally speaking. So that's 351 and it's, no, it's, there's basically no strings attached, but you have to contribute diversified property.

Now the other question, like people always say is Wes, I got my $100 M Tesla, but that's all I got. I'm like, obviously you're not diversified enough to qualify for 351 and, we just, you can't do this, man, it's illegal, it won't work. And they're like, that's great, what am I supposed to do? And, you basically have two solutions, right? You can either go to an exchange fund, and we've done some innovation on the exchange fund side with a group called Ca$h, which is, they're think best way to think of. It's like the Vanguard of exchange funds. It's exchange funds, if you're aware they're like these old stodgy, overpriced structured product type businesses the banks have been operating for 30 years, and it was about time a competitor came in. And so we have that competitor, it's called Ca$h. but it, so it's lower costs. There's a lot of efficiencies they have.

But the key thing in the tax rule is that, that relates to another section called 721 related partnership taxation. And so if you contribute concentrated property into a pooled vehicle and you achieve diversification. So this is a situation where like, I put in my Nvidia, you put in your Tesla, Suzy puts in Microsoft or whatever. We all benefit because as a partnership, we're diversified even though we, each individual contributed this, 721 basically says, great, you guys can do that. But there's strings attached. You have a seven-year lockup, and you also, you can't be an RIC, and there's a bunch of other rules.

But long story short, if you have concentration problems where 351 can't help you, you have to do the exchange fund, which again, there's new solutions that are a lot better than they used to be, but you always are going to have the seven-year lockup problem, because that's just the tax code. So that's solution one there. And then solution two, which, I spoke to Rod about to get him up to speed on, and this is something we also did 10 years ago, before I think even people were thinking about this, because we used to always, we always do tax things, but you, basically what you do is you do the long/short tax loss harvesting.

So, you run like a market neutral system alongside a concentrated asset. And then over time, when you're running your market neutral thing, you can generate losses. And then as you generate losses, you can use that to sell down your concentrated position, and it, the bases squeezes into the long leg. So that's kind of your, there's other things you can do, but those are the two things you can do if you got the concentrated risk problem.

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[00:20:22] Wes Gray: Yep, and, the way that the, this was all argued about many decades ago, and the general intent of the tax code is they're like, listen, we don't not like it when you go from concentrated to diversified, so therefore we're going to require a penalty. And that penalty is that seven-year lockup and a bunch of other crap. However, they say, but if you're already diversified, at least how we define diversification, we don't really care if you do a 351, because in our mind you're already diversified. You're just going to get more diversified, or whatever.

So, the tax code is basically set up to penalize those that have too much concentration, but not penalize those that have enough, that they consider diversified already, which kind of doesn't make sense because you would not, you'd almost think if I'm like a macro policy person, trying to free up capital with least frictional cost, you would actually think like you don't want people bearing massive idiosyncratic risk all the time, because the cost of capital goes up, there's all kinds of friction problems.

But that's how it is set up. They actually make it painful to deal, diversify essentially, and that's why the market neutral stuff is kind of like a “new innovation”, where it's another alternative to the seven-year lock structure, that kind of goes around the seven-year lockup.

There's implied lockup because it's, it's not like you can just do that in a minute, take, it might take three or four years to generate it, but it's a nifty, I guess quant solution to, I wouldn't say go around the seven-year rule, go around the seven-year rule, in some sense.

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[00:22:20] Wes Gray: Yep.

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[00:22:52] Wes Gray: Yeah, let me, yeah. Let me give you the cost/benefit, because there's not like a panacea where it's oh, we always should do this solution, we should always do that solution. So generally speaking, if you have 351 qualified contribution, there is an easy answer. Do the 351 because that has no lockups. You get immediate diversification. That is a no-brainer. Frankly, if you already have diversification, and you want to do a 351, that's obvious.

But let's get to the contrary position, which is a lot more complicated because now we got trade-offs, right? So option one, the leanest, meanest option was, and I'm going to oversimplify this, just to make this simple to understand. It's not this easy, but it's basically what's happening is I can't take, let's say you got your $50 M Tesla. I can't take that directly. It's not 351 qualified.

What if you go to an exchange fund in particular, this group Ca$h, who basically invented this solution, and it's a long story why other people can't do it, but there's actually a lot of IP involved. But, so that's why I was giving the nickel to her. So I can't take the Tesla, call up these Ca$h guys, all right, and what are they going to do? Basically, they're like, all right, we're trying to manage to an index, and I've got Adam's Tesla, I got Susie's Nvidia, blah, blah, blah. They, at the partnership level might be able to get a diversified portfolio that they could contribute to a 351, right?

And this is exactly what we actually did on one of our deals over the summer with a U.S., where the exchange fund was actually like $130, $140 million of the, almost $500 million total capital. They were a big contributor. And, so let's say 300, 300 change was like normal 351 folks. The rest was exchange fund contributed, right? And so what happens there is exchange fund contributes these securities under 351. I can give 'em back the ETF shares and they can do that in a tax free manner.

Now they have a problem on their side with all the legalities and structuring and how to make sure that all this is kosher. But essentially you as the person that says, hey, here's my $50 M Tesla, Effectively, you're going to become S&P 500 the next day. And you're, yes, you're going to have to hold this for seven years and be exposed to S&P. I guess you could hedge against it if you wanted to in another account.

You're basically going to go Tesla immediately to S&P 500. And then after the seven-year hold period, when you, when the events aren't deemed taxable and redemption, you can say, hey, gimme my collateral, and then you'll receive out of the ETF, and then you just walk off to the sunset. That's solution one. And, they've got the cost on the, all in cost on that to probably, depending on your scale, anywhere from 30 bips, to like a hundred bips all in, which is great. And if you have a lot of scale, you're going to be in like the 30 bip range. If you do a $100 K, it's obviously going to be more expensive. and that has like different costs and benefits.

And then on the long/short side, what you do is you're like, all right, great. I'm going to get my $50 M Tesla, hold that in my brokerage account, use that to borrow and fund a market neutral long/short strategy. It just, say it's a thousand long, a thousand short, it's doing some factor thing or whatever.

But let's just pretend that it's a break even strategy. Like it, you're not good at picking factors in the end and you're just like, let's just abstract from the investment part and just talk about the tax part. So, let's say you have the $50 M Tesla, you're like, great, we're going to go put $10 M in this market neutral strategy. It's going to go long a thousand, short a thousand. And then, you know, generally speaking it differs year to year, but you might be able to generate, call it on that $10 M, you might be able to generate $5 M a year, or $10 M a year in losses, right?

And so let's say you get that $5 M a year in loss. Now I can take that loss, pull my Tesla down to $45 M, u-hedge, and then I'm usually going to be basically long $5 M of the thousand leg of my market neutral portfolio, and I've effectively moved from, instead of $50 M all in Tesla, I'm now $45 M Tesla, $5 M, like a random thousand stocks long, effectively, right?

And then if you do that for let's say four or five years, maybe you get the Tesla position all the way down to zero, and now all you have is basically a bunch of basis in a thousand random long stocks. And maybe you've already un-hedged your short side, and you've transitioned your tax problem from Tesla into these, diversified long leg, essentially.

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So we actually manage private and public funds as well as bespoke separately managed accounts for investors that seek the potential to smooth out portfolio returns in the long run. So, if you do want to see that theory that we've been talking about put into practice, please do go ahead and check us out at www.investresolve.com. Now back to the podcast.

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[00:28:49] Wes Gray: Yeah, so generally speaking, on average, and this stuff's extremely complicated because it's all path-dependent, obviously. So, usually the operators that do this, they're going to have like their Monte Carlo, we're going to simulate 10 million simulations of this. But generally speaking over long horizons, beta works, right? Beta pays a premium. So just owning risk, on average it goes up. So, if you're long a thousand stocks, you're short a thousand stocks, and you're sector neutral, everything neutral, because you can't be long and short the exact same thing, because you create like straddle problems and some other issues.

But, you can, as like a quant, you can effectively be long a thousand, short a thousand and not really be taking that much risk. Like, you actually want to take risk for tax purposes, but you could engineer, in theory, something that basically has no risk ,effectively, just for easy math, right? And then what happens is the short positions are on average always losing because they're short the market beta, right?

some stock that doesn't go up: 10000

So you might, if you thought it made sense, you would actually cover that short, right? Bank the short-term capital loss. You'd have to do some management because now you're not exposed anymore. You'd have to figure that out. But then over time, as you're doing these kind of trades and you're like banking, like whenever something's in a loss position, either on the long or the short side, you bank it, and then you either hedge it, you wait 30 days because you got to deal with the wash show rules too. The main idea is, over time, most of your losses are generated in your short book, some on the long book, but in the end, like after five years in these programs, pretty much all your basis is going to be buried in 10 to 20 long names. It's going to be like what you would expect.

Like right now it's going to be Nvidia, Microsoft, Tesla, these sort of things. And then you're going to have a long tail of like long names that kind of have some basis, they got some tax issues, but not a ton. And so what you would do at the end of this lifecycle is you're great, I finally got rid of my concentration. Now I'm in this crazy complex market neutral thing that it's did its job, but do I really need all this complexity? No. So you would basically close down your, you'd have to do this in the most tax efficient way possible, which wouldn't be too hard.

You'd basically close down all your shorts, close down all your longs that weren't creating a tax problem, and then you'd be left with a basket of these really low basis kind of like, left tail, you know, 100X type stocks, because that's where all your tax problem is. And then you could just hold onto that, obviously. Or if you wanted to, you could then 351 that, because now you're 351 diversified, and then you could go become S&P again if you wanted.

So I, it's complicated, but if you just were really crazy about like diversification and planning, you could do things like this, where you actually piecemeal these different programs after they've done their value add, and then you keep rotating into the next thing.

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[00:33:07] Wes Gray: Yeah, exactly. Yeah.

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[00:33:24] Wes Gray: You just need like a quant or like someone with computers, obviously, because to your point, it's weirdly, you actually want a lot of volatility if you're trying to get rid of your Tesla prop, because to your point, the more you got things zigging and zagging, that's just more opportunities to take this tax loss option and just bank these things.

So even if, the market doesn't go anywhere and, but just stocks move, you're still going to be able to generate a lot of losses. It's just now the, where your basis is, might be not what we talked about initially there, like over a long horizon. It might just be spread all over the place. And that also gets complicated, because the issue is, on like short side, for example. there's no such thing as a long-term capital gain from a short position. Like at least in, maybe the code's changed, but at least last time I looked, even if you hold a short position for two years and you're like, all right, fine, I'll just cover it, they're going to still ding you with short-term capital gains, whereas obviously you don't have that treatment on long positions. So all else equal, you don't want to be like having a per or push your unrealized basis into short positions, because when you do have to finally pay the man at some point, it's not capital gains long-term. It's short-term capital gains, which is double the rate.

So you don't want that outcome, obviously, but that would be something when you simulate, you're like, that'd be one of the outcomes where you're like, man, and I, if you read, AQR has a bunch of papers that do exactly what I'm talking about. They simulate 10,000 runs and they give you the confidence bands of well, after three years, you're going to be between this and this. After 10 years… and they're basically highlighting that it's all path dependent, and all we can do is give you a cone of expectations.

But obviously, unfortunately you get run one roll at the dice here. We only have one observation and you're just going to have to deal with that. So all we can do is just invest ex-ante the best we can, but we can't predict the future,

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[00:35:55] Wes Gray: More limited. Yeah, you're going to get more limited issues in your long and your short book. But generally speaking, it's, you're usually going to have some tax problem. You can't eliminate the tax problem because it's like the physics of tax. It's any, it's going to get squeezed somewhere. It's just going to be under, it's going to be unrealized somewhere else for sure. Because you can't eliminate it through these mechanisms.

doing stuff like this in the: 1042

It just, it can't be possible. And sure enough, it's just, it's this physics of tax. There's, unless you die, there is no way to eliminate it. If you want to kill yourself, great. They'll give you like a, that way you can get rid of your tax problem, but you got to die. That sucks. But generally speaking, the tax will show, the tax burden will be somewhere. It just, it's, we just got to know what form it showed up in. It's going to be squeezed into either short-leg , or long-leg, or somewhere. There's just no way to not have that be plausible, unless of course the initial problem. Like you, let's say in this case your Tesla, it goes down by 50%, 60%. You don't have the tax issue anymore. That, that's a good way to also …

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[00:37:39] Wes Gray: But, yeah, so the two solutions to eliminate tax problems are die or lose your ass and not have the tax problem. But those are also corner solutions that suck. It's not like an equilibrium that any of us want, and so I would say it's always going to be the case that it's just a matter of when you're going to pay the man. You know it, but you're going to pay the man at some point.

It's just, can I at least make this ride more diversified and more efficient as opposed to just like, doing the Bitcoin trade. Just, I'm just long and strong till it goes to a million and I'm going to endure ten 90% drawdowns along the way. You guys write about that all the time. Like, there's a utility benefit to not have your curve go like this all day, and make it wiggle a little bit less on your way to whatever financial objectives you got, and so that's really…

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[00:39:03] Wes Gray: Damn near zero. Exactly. Yeah. it's and I'm sure some academic or quant could map out the utility of that, but it's got to be, the implied loss of expected return and utility benefit, it's got to be insane, man. I don't even know, but I, it's terrible. It's, it'd be like equivalent to saying, do you like investing in equities and earning a negative 20% equity premium?

You should buy this idea. Like it's going to be something like that absurd where if you framed it in the correct manner, people would be like, why would you ever do that? That's totally insane. To which I'm like, yeah, no shit. And yet people do it all the time.

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[00:40:01] Wes Gray: To be fair. the other thing is, and Elon's done this, this is all like the billionaire tricks, which is how we were raised. You can always go to your friendly banker and say, hey, can I pledge this Tesla for cash? And it's, they're like, yeah, of course you can.

And remember, if you take loans against your position, that's tax free and you could go buy S&P 500. So there's all, if you're rich enough, and you have enough banker friends, and you're doing everything within the letter of the law, you can already do a lot of this and get rid of those problems. It, just because, and it makes sense that you do so, because even though you gain so much utility benefit in the vacuum, if you have to pay 30%, 40% in a capital gain, it's worth thinking about how do I do this?

Because, that's like a huge problem, and that's why, obviously, people spend so much money and time on trying to figure out a tax efficient solution, because it's just the capital gains, the state, the Obamacare. it's crazy.

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[00:41:52] Wes Gray: Yeah. so what you would do is what you guys already do in your business. Hey, I'm, you obviously have to have a positive cost to carry, so if I have, let's just make it up. I have $100 M Tesla. I'm just, I am such an Elon fan, I'm not selling this. I don't care how many Best and Binder studies you give me. I'm just a religious believer.

Fine. We're not going to argue about that. It's just, we'll give it to you. So what can I do for you? What I can do for you is, if I borrow against that position, it's going to have a cost to carry, because obviously the broker's going to charge me whatever Fed funds plus some haircut.

But, and let's just say for easy math, that's 5%. But you are like, guys, it costs me 5%, but I can take that capital and go invest in like merger arb, market neutral, trend following, all the 10 different games that maybe you guys would invent, like all the kind of totally uncorrelated, the classic kind of portfolio theory, put a bunch of totally random shit together.

And even though all of them individually look crazy as a bundle, you created like a T-bill basically, right? So if you could say, hey, I got this bundle over here and it actually earns 7%, and it only costs me 5% to fund it. That's a positive carry trade for free assuming you could deliver the 7%. And not only that, because of what we were just talking about, all the tax optionality, behind the scenes, I can always take options on banking losses for a rainy day. So then I can also generate some “tax alpha”, if we're going to call it that, right? So in a perfect world where you just have someone who's a maniac and they're just like, Adam, you're an idiot. Shut up. I'm rich. You're not, and Tesla made me a gazillionaire, I'm not leaving.

Fine. How about this, bro? We're going to run like an overlay funded with the collateral, and I can convince you I can beat your cost to carry. And so you basically get “free money and tax loss benefits”. Obviously that would be a good pitch, assuming you could deliver on the value pro. Yeah. You don't want to have negative cost carry, obviously, but if you could actually generally convince someone that you could execute, that's a great idea.

[: 00:44:14

[00:44:19] Wes Gray: It's so, generally speaking, like interest expense, is deductible I think against other investment income. That's so I'm not a CPA, I don't do, I'm not like a CPA day-to-day, I can't remember those rules, but margin expense, like margin interest is deductible against other, I think like qualified investment expense income.

So like you can't use it against like your business outside of your investments or other, or like your W2 income. but you could use it against - let's say, you own something that provides income, like you own some bond or whatever, right? I'm pretty sure you can use your margin expense on that loan against that, right? That's something that, because that gets super in the weeds real quick, and I'm not a tax attorney or whatever, but CPAs are all over that, and they'll be able to say oh, this one can match that one. But there's certainly, it's not all bad, because of what you said, like the, in it is definitely deductible against something. You just want to make sure that you have something that can be deducted against to make sure you can use it.

[: 00:45:30

[00:45:42] Wes Gray: Yeah, I mean I personally do that. I borrow against my stuff and go put it in funds that do this kind of stuff, and I'm almost positive, I don't know, but if you go went, if you went to go do the funding sources on like the Citadel Hedge Fund, Millennium, all these like prop shops, I can almost guarantee that's people that are funding those LPs with borrowed money, right?

Because if I can go borrow money from my broker at 5%, go give it to them. Like I would venture to guess that a vast majority of the capital they have is not clean money, where people just took cash that was just sitting there. It's probably almost certainly overlays, indirectly. And so I already think that's a massive, huge business out there. I just don't know how much it's trickled down to the ultra high net worth taxable folks out there. I recommend it all the time, but I don't, it's not my business anymore. I got too, I'm buried too much in just doing the tax structuring with ETF stuff. I, we can't do all this stuff, but yeah, someone should definitely, duh. This is obviously a huge business opportunity and I know AQR does it, some other guys, but this should be way bigger opportunity. But the, but as the problem is, it's complicated,

[: 00:47:01

[00:47:01] Wes Gray: So you’ve got to explain all this, how the financial engineering works, and so there's a massive educational tale, but it's obviously a great idea because it creates a lot of value.

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[00:47:29] Wes Gray: Yeah, of …

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[00:47:55] Wes Gray: Yeah. And you guys do that on Return Stacking. It's just, it's a different mechanism. but the idea is like, all right, you have all this collateral, but you can't do anything with it, because it's stuck for taxes. That doesn't mean it's worthless because it's collateral. I could use that to get margin and then go fund other games out there.

It's just, and that makes total sense. It's just being capital efficient basically. And I don't think it's, I think it's a huge business amongst like the billionaires and, because obviously the banks pitch stuff like this all the time, but I don't know how much it's pushed down into the small millionaires, or like the RIAs and this sort of thing., just, I think it's getting there. Because all those big shops are already selling like the tax harvesting thing now to like RIAs. So I assume the next step would be like, what about overlays, which is basically what they're already doing. But there's huge room in that marketplace for, basically for guys like you. You guys are in that biz, and now you just got to go find people that are like, oh, that's a good idea. I listen to this podcast with you idiots talking, how do we do that?

[: 00:49:09

[00:49:10] Wes Gray: It is just things like this. People just got to be aware that's a possibility.

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[00:49:34] Wes Gray: Yeah, of course, we did that for 15 years. at IB. The problem is IB started jacking up margin requirements on that thing. So we got out of that. But yes, you should all, if you're doing any strategy that creates tax leakage and you can fund another strategy that can decrease tax leakage, you should do that. So yeah. that's…

[: 00:50:01

[00:50:13] Wes Gray: The problem there though is as, like in registered funds, we have to qualify as an RIC. So the issue is like, the problem is you got to, in order to be able to do futures, a lot of times you got to set up the Cayman to avoid the bad income problem, and now you just turn 60/40 capital gain into income. Guess what? The tax loss harvesting programs don't create capital. They don't create income losses. They create capital losses. So you just shot yourself in the foot. But LPs and partnerships should 100%, if you're running like a futures strategy, or anything that's generating like mark to market 60/40, you should definitely be running market neutral as well because now you can help, you get an alternative exposure, obviously that's cool, but also from a tax perspective, you have a little engine that's punting out your 60/40 all the time.

So yeah, that's, I would assume a lot of people do that. They're, if they're dealing with taxable clientele and unfortunately in our world, because I've had people ask me that - hey, why don't you run this inside the ETF? And as like one, the RIC is a huge pain, but then two, can you imagine if we went to a market maker and said, hey, we're going to run this long-only thing, and then we're also going to do a market neutral long/short, that they're going to be like, what planet do you live on? Get outta here. I'm not market making anything that smells like that, because we just have so many more constraints from just, like an Interactive Broker's account. Unfortunately, it's just not viable. But in private accounts, SMAs, LPs, obviously you can do whatever you want.

[: 00:51:56

[00:52:12] Wes Gray: They…

[: 00:52:13

[00:52:30] Wes Gray: And I, don't, yeah, I would look at the AQR funds. I haven't studied them, but almost certainly like they're big mutual funds. Because they're obviously one of, they're big and the harvesting market, neutral harvesting. I can't imagine that they haven't magically created less distributions in their mutual funds over the last few years as they've been like, oh duh, we should probably get tax efficient now because everyone hates us. Which, should have thought of that 10 years ago, guys. But I get it, better late than never. So now that they're cognizant of this, I'd imagine they're getting benefits in other areas of their business, and they would be like the ultimate candidate that I would look to, to see evidence of that, because that seems like a no-brainer to me.

[: 00:53:18

[00:53:28] Wes Gray: Yeah, for sure. the downside is obviously the pain. Like we used to run market neutral strategies back in the day and as, like, running a short book, it's crazy bad, because you're getting recalls all the time, and as you can imagine, that's really complicated when you're also dealing with tax, because it's one thing to have a recall in a short position where you just lost money. But now what, let's say that recall happens and it's in like, a gain. Let's say short Nvidia or something crazy and it's just, it actually, that one would be all right because it would force you into a loss.

But let's say you have a big loser, like the, now you have a massive unrealized capital gain, and all of a sudden you get recalled. Now you have to realize it, you destroyed the whole purpose of the program in the first place.

[: 00:54:20

[00:54:23] Wes Gray: Yeah. You're earning your management fee I would say, if you figure that out. So you're not going to get Vanguard offering that for three bips, for sure. They'd be like, you're crazy. So definitely an opportunity, I think.

[: 00:54:40

[00:55:06] Wes Gray: Yeah, so here's the problem with Boxx, right? The problem with Boxx is we can't talk about tax because of section 1258. So I just, we never make any public statements about the taxation of Boxx, because it's just, it just actually causes problems for people.

ed options fall under section: 1256

That ain't going to work, because as, if I buy the T-bill at 990 and it accretes to 1000, that's income. There's a big difference as we're talking about here, between income and capital gain. Even if it's 60/40 mark to market. So if you're running those same trades, you're doing a box spread on your collateral, you know you're going to earn TBI usually, plus a little bit.

were doing box spreads on SPX: 1256

[00:57:57] Adam Butler: Amazing. Yeah,

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[00:59:04] Adam Butler: Yep. Yep. Absolutely.

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[00:59:43] Adam Butler: Yep.

[: 00:59:44

[00:59:47] Adam Butler: Yeah, it's really cool. I've been needing to climb a learning curve over the, on this over the last few months and see all the different directions that you can take it, and it's definitely an idea which time has come, just in terms of the Overton window. Like, it's amazing. Just everyone seems to be really interested in this now, again, probably not surprisingly, given where we are on the S&P and stuff, but it is…

[: 01:00:09

[01:01:01] Adam Butler: For sure. Awesome. Look, I kept you for the hour that you promised, and you've been a wealth of knowledge as usual. Thank you so much for sharing. Are you guys still doing the March every year or is…

[: 01:01:16

And then in a, just because, you got to haze people, we're going to do a little March for the Fallen and just remember that stuff. So once we get plans on that, I can talk to you guys about it, because you guys are OGs on that and, it might be fun to rally up the troops there. But yeah. So we are bringing it back, but it's been a a challenge to try to figure out how we get…

[: 01:02:25

[01:02:27] Wes Gray: … exactly. So same idea, same function, but different venue, different setup and everything.

[: 01:02:34

[01:02:48] Wes Gray: I love it. We'll see Adam, good luck out there, man.

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[01:02:53] Rodrigo Gordillo: I did want to take a quick second to remind our listeners that the team works really hard on these podcasts. We spend a lot of hours trying to get the right guests and we do a lot of prep work to make sure that we're asking the right questions. So if you do have a second, just do hit that Subscribe button, hit that Like button, and Share with friends if you find what we're doing useful.