FOR EVERYONE'S EDIFICATION....
HF compensation is based on a management fee and a percentage of the profits. The original model used to be 1/20, 1% management fee (one twelfth of one percent monthly in arrears of the account ending balance) plus 20% of the profits at year-end, if there were any, or upon redemption mid-year (crystallized)).
The model works well if you have lots of assets under management (AUM), but it is very difficult otherwise. In past years the fee schedules have changed, lock ups have come and gone in trying to guarantee an income stream for some time, etc. What the market values is liquidity and capital preservation. Folks looked at 2008 and 2009 and asked a question or two: "Who did not lose money in 2008 and who made money in 2009?" That is where the money went, in large part.
Managers that were down 40% in 2008 closed shop after putting up gates trying to prevent redemptions, for the most part. In order to get to the high-water mark, you would have to be up 66% before earning a performance fee. Better to close down, erase your performance history, and re-establish yourself under a new shingle with a new strategy 6 months later. That is why a track record in this industry is invaluable and irreplaceable. That is your pedigree. Be wary of short track records.
Now onto the supposition that taxation is favorable. Well, it is not so... You see, the "carry provision", as it is called in the industry, was eliminated post 2007. This meant that one could not have the profits of an offshore fund remain offshore and compound prior to being repatriated, say 10 years later, at the then current tax rate. There are a lot of assumptions one had to make at the time, including your ability to provide excess returns and to mitigate the taxable exposure in the future.
So when an offshore fund, or a domestic fund, such as a DE LP, pays a performance fee to a GP or management company, it is taxed as income to that company, at the current US rates. The GP may have some of the gains rolled into its account and it will receive a K-1, with ST and LT capital gains, but if one is a true hedge fund, then the balance of the longs and shorts will result in 80% or so being short-term gains, taxed at ordinary rates. If the fee is coming from an offshore fund, there is no K-1 and it is all ordinary income. Short sales are always ST gains.
So you see, it is a publicity stunt in my opinion. There is basic fairness already in the system. The carry forwards are quickly coming to an end as one cannot defer longer than 10 years, i.e., the last tranche of deferral will be coming back to the USA circa early 2016 at then current rates. One can bring it sooner, but does anyone really think rates are going to be lower in the future? And how much lower? I don't.
To summarize, that is the industry where the vast majority of the profits are taxed at high rates, not the low 15% tax rate for LTCG, especially if there is any turnover. With a flat market over the last 10 years, most funds have not been tax efficient, essentially.
So yes, throw the allegations back to the administration that wants to make class warfare an issue. Ask them why the $30 billion in legal deductions that the oil industry takes is so different than those of any other industry? Ask them if $30 billion is going to make a difference in a budget that needs cuts of $1.5 trillion by December? But lastly, ask the administration if producing tax incentives to hire employees is going to work if you then decide to tax the corporation at the other end by reducing the deduction and in effect, producing no real incentive? So the President is asking for an additional, roughly, $500 billion on top of the $1.5 trillion. Another classic, class warfare proposal as a whole. The government needs to spend less, ask everyone to pay at least a little, and to live within its means. The wild swings are driven off a system that relies too heavily on income taxes from the rich and a base that is not broad enough. So when the rich make less and there are fewer millionaires, the government's take is much smaller, e.g., California today and the USA. Our revenues are 14.8% of GDP vs. roughly 18% of GDP historically. Our expenses are 25% of GDP today vs. 20%-21% historically, where we ran a 2%-3% deficit. You want to make an impact, cut expenses, regulation, i.e., Obamacare, Dodd-Frank, late EPA mandates, etc. I am all for closing loopholes, but do it across-the-board, uniformly so that we don't pick winners and losers. And put term limits in place too while you're at it to keep corruption down.
You see, what you have here is more of the same class warfare, a tried and tired argument that has failed. Government should pick policies that work and we already know that the $870 billion stimulus did not and neither did other stimuli of earlier administrations of the same sort. Therefore, the answer seems obvious to me: get out of the way and do nothing and let business and the market find a floor. DO NO HARM.
I hope this primer help -- from someone with practical experience about the subject matter at hand. Again, my personal opinions are presented here.
And by the way, the downside is that you go out of business in a heartbeat if you don't perform and don't put up with the incredible costs, infrastructure requirements, reporting requirements, regulatory requirements, etc. So yes, there is incentive, but not all make it. One never hears about how many go out of business, only of the large wealthy ones that did well, many by a stroke of luck or timing, many by hard work. By definition, half of the funds will have to at least underperform the market, if they are the market.
Best regards -- |
