Wall Street is agog over the latest tax avoidance hedge fund strategies, pioneered by AQR Capital Management, which account for more than $100 billion in assets under management. But the critiques are coming — even from inside the hedge fund tent. 

Nate Koppikar, cofounder of short-biased hedge fund Orso Partners, says the “tax avoidance” of these products has become an asset class that ultimately may not withstand regulatory scrutiny — and is also heavily reliant on significant leverage, creating a “ticking time bomb.” He even compares AQR’s products to Renaissance Technologies’ “options basket trade” that in 2021 resulted in a multi-billion dollar tax settlement with the IRS. 

Known for his prescience in spotting the technology bubble in early 2022 and the trouble in publicly traded private equity firms in 2023, Koppikar is now shorting Affiliated Managers Group, which owns a minority stake in AQR. AMG’s CFO has said that the company expects AQR to account for more than 20 percent of its earnings this year. AMG did not return a request for comment.

AQR’s total assets surged by a record $65 billion in 2025 alone. According to Bloomberg, the firm’s tax-aware business had tripled in size last year by September, when it was $45 billion. By year-end, more than a third of its total assets of $179 billion were held in tax-aware funds. AQR now has about $68.8 billion in what it calls tax-aware products.

The timing of the recent growth is not surprising, says Daniel Hemel, a law professor at New York University who specializes in taxation and is familiar with these strategies. “The IRS has shown little willingness to crack down on loopholes under Trump. So the outlook for tax-aware funds is definitely better in April 2026 than it was in October 2024.”

Others have been copying AQR, including Hoon Kim, a former AQR principal who started Quantinno Capital Management, which now runs $48.4 billion in these strategies, according to its website. Others include Two Sigma and WorldQuant. Both firms declined to comment. Quantinno did not respond to an email requesting comment.

Koppikar argued in a recent letter to Orso’s investors, obtained by Institutional Investor, that while these strategies may appear legitimate, their economic outcomes could draw regulatory scrutiny.  

He explained that when the sale of an asset creates a huge capital gain, to avoid paying tax on it, the owner can immediately put that money into an AQR account that goes both long and short numerous stocks, often using copious amounts of leverage.

The idea is to keep the long positions but cover the losers (theoretically mostly shorts) to create tax losses, he said. As long as no gains on the winners are realized, no tax is incurred on them. At the same time, the tax losses accumulate. And if an investor holds on to the gains until death, Koppikar explained, the assets can be passed on to heirs with a stepped-up basis under U.S. tax law, making the strategy one of “generational wealth transfer.”

Koppikar continued, “Looking under the hood, the true ‘alpha’ of this product is simply extreme tax avoidance. The mechanical goal of the fund is to aggressively realize net capital losses on the short side while perpetually deferring the realization of gains on the long side.”

AQR did not return several requests for comment. But according to a marketing presentation II saw for an AQR product, Flex SMA, the strategy “targets meaningful potential excess returns while deferring capital gains and realizing tax losses.” The strategies with the highest leverage and volatility can theoretically earn a pretax net return several percentage points higher than the broad market, according to Flex SMA marketing materials.

But, Koppikar pointed out, Flex SMA projects cumulative net capital losses of 723 percent of invested capital over ten years — “a staggering figure that underscores the primacy of loss generation as the product’s fundamental raison d’être,” based on marketing presentations.

“To manufacture losses of that magnitude, AQR has to run these strategies with massive gross leverage,” he wrote. The upper end of leverage implies 600 percent of gross exposure, or 6x leverage. According to Koppikar, that means AQR is pushing the limits of retail broker portfoliomargin rules. “Standard retail margin (Reg T) caps gross exposure at 2x. Even aggressive, institutional long-short equity hedge funds typically cap their gross exposure around 200 percent to 250 percent.”

Koppikar suggested that the success of these products could be their undoing. “The operational mechanics of this trade are also beginning to fracture in ways the market has not priced. In February 2026, Fidelity instituted an indefinite restriction on RIAs placing new client assets in long-short SMAs on its platform.” He noted that industry sources say that’s because Fidelity needs to “build out risk process to handle the sprawling short books.” 

Koppikar called this a potential constraint, saying that “if regulatory action forces custodians to reconsider the risks of facilitating these structures, the entire AQR Flex SMA growth engine seizes up overnight. Fidelity’s move is a major tell — a risk-averse financial institution concluding that the operational and regulatory tail risks of these products no longer justify the fees.” 

One individual familiar with Fidelity said the firm’s decision was driven by the huge growth in the business in recent months, adding that it wanted to see other custodians get involved.

“This decision reflects Fidelity’s long-term approach to monitoring resources across the platform as we manage the growth of long-short SMAs,” a spokesperson for Fidelity told II. She declined to comment on any concerns about regulatory risk.  

Even though the Flex SMA product works for those wanting to shield capital gains from taxes, Koppikar said other tax strategies can also be used to avoid paying income taxes.  

One AQR product, the Delphi Plus fund, is the “most aggressive” iteration of the firm’s tax-aware strategies, he explained. Delphi utilizes notional principal contracts — swap agreements — to generate ordinary losses that can be deducted not just against capital gains, but against W-2 and business income, he said, citing Bloomberg. “This is the holy grail for the ultrawealthy: a product that produces investment returns while simultaneously manufacturing losses that wipe out their taxable income from wages.”

But Koppikar argued that Delphi’s use of swaps could bring the product into conflict with the IRS in the same way that Renaissance was targeted: “The use of swap structures for tax optimization should set off massive regulatory alarm bells.”

The parallels with Renaissance are that “both involve sophisticated quantitative firms weaponizing derivative overlays to manufacture tax benefits that exist independently of any genuine investment thesis,” he said. “Both the [Government Accountability Office] and the IRS’s Office of Promoter Investigations have specifically identified the use of financial derivatives to alter the character of income as a core target for abusive tax avoidance.”

According to Hemel, that strategy is the one most likely to be targeted by the IRS at some point. “The IRS could stop it because it is using derivatives to generate ordinary losses.” Another individual familiar with Delphi Plus agrees that it is the AQR product most vulnerable to IRS action.

Koppikar mentioned several other tax avoidance schemes eventually shut down by the IRS, noting that “every single one of these strategies shared the same fatal flaw: They used complex financial engineering to manufacture a tax benefit entirely divorced from economic reality.”

That said, Hemel isn’t so sure the IRS would shut down the Flex SMA strategy. “Tax-aware funds that generate ordinary losses they then pass through to their limited partners to offset active business income [are] really a function of Treasury’s good graces,” he said. “It’s not even a loophole created by Congress. It’s a loophole created by Treasury and the IRS, which have carved out trader funds from the passive activity loss limitations.”

But precisely because the practice is not protected by law, Koppikar thinks the strategy is vulnerable. 

Looking at the bigger picture, he said that “in an America increasingly attuned to wealth inequality, the discovery that a founder can sell a business for $5 billion and utilize AQR’s loss-generation machine to fully offset the capital gains tax over time — then pass the remaining appreciated portfolio to heirs with a stepped-up basis, effectively reducing the lifetime tax bill to zero — is simply not a sustainable business model.”

In the disclosures section of Flex SMA’s marketing materials, AQR does mention the possibility of regulatory pushback. “The expected tax benefits associated with the tax-aware strategy may be less than expected or may not materialize due to the economic performance of the strategy, an investor’s particular circumstances, prospective or retroactive changes in applicable tax law, and/or a successful challenge by the IRS. In the case of an IRS challenge, penalties may apply.”

The IRS declined to comment.