A strategy of adding borrowed short-term securities to a long-term portfolio to maximize the tax advantages is becoming more popular in investing circles.

The practice, often referred to as 130/30, has been used for years by large institutional investors, but the CFA Institute recently published a study highlighting the strategy's tax advantages.

"This has always been pitched for large institutional investors, but the emphasis was not on tax efficiency," says Stephen Horan, CFA head of professional education content and private wealth. CFA Institute is a global, not-for-profit association for investment professionals.

Also known as long/short investing or extended equity mandates, 130/30 involves borrowing from a long-only portfolio to buy securities on a short-term basis. This creates opportunities for loss-harvesting for tax purposes by timing sales that result in losses to offset taxable gains. It also makes possible tax arbitrage caused by differing tax rates on similar economic events between the long and short positions.

The strategy creates an additional element of diversity in a portfolio, adding differing time frames to the different classes of assets that are part of a diversified portfolio.

A portion of the portfolio, typically 30%, is sold short. The proceeds are then used to leverage an additional 30% investment on the long side. In addition to allowing more active bets on a pre-tax basis, the 130/30 strategy allows  the money manager to time sales to realize losses on short sales in order to defer gains that would have been taxed in a long-only portfolio.

"It is a complex strategy that requires a high degree of technology to track the portfolio in order to track each security's costs basis and to buy and sell at the right time to capitalize on changes in holding periods," Horan says. "It is not for everyone but it can decrease taxes and increase profits for the very active investor."

The practice is most useful for active money managers rather than individual investors, but it allows a systematic approach to managing taxes, rather than just addressing the return on investment and letting the taxes fall where they may.

The 130/30 approach enables a fund manager to use his or her expertise to actively buy and sell equities based on predictions of their worth. If they lose value, the losses can offset taxes.

"The strategy is not without its risks, but there is a simple concept of diversification imbedded in it," Horan says. "If all the securities in a portfolio move up and down together, there is no opportunity to recognize loss in one to offset gains in another."