The Role of Alternative Assets in Tax-Efficient Portfolio Construction

Abstract

The author considers the role alternative assets play in a taxable portfolio and suggests that investors who pay taxes ought to have a greater portion of their wealth, ceteris paribus, invested in alternative asses relative to tax-exempt investors. The analysis starts with the intuition that fix-income assets are relatively tax-inefficient, and the diversification power of alternative assets should lead them to play a greater portfolio role. The author compares the results of pre- and after-tax portfolio optimization. He suggest that, in line with the original intuition, investors who optimize their asset allocation on an after-tax basis will seek a greater exposure to equity and alternative assets than those who ignore the impact of taxes at the asset allocation stage. Furthermore, an analysis that biases the decision process toward minimizing taxes rather than risks shows that the optimizer shifts even more dramatically out of fixed-income investments toward alternative assets.