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What are hedge funds, and what social functions do they serve?

danwang.co

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Re: What are hedge funds, and what social functions do they serve?

#81

Post by damoncali »

bza wrote: post #56
soupboy wrote: post #46

> How did a few asset managers earn more money in a single year than Pierpont Morgan did in his whole life? Ummm, no they don't. $1 in 1913 is around $24 in today's dollars[ http://data.bls.gov/cgi-bin/cpicalc.pl?cost1=1&year1=1913&ye... ]. So JPM's net worth today would be $36 billion making him the 12th richest person person in the world [ http://www.bloomberg.com/billionaires/2014-09-19/aaa ].

The $1.5 billion figure given in the article is already in today's dollars.

JP Morgan was far richer than that in his day. It's disingenuous at best.

Re: What are hedge funds, and what social functions do they serve?

#82

Post by hsitz »

onetimeusename wrote: post #74
frandroid wrote: post #67

Earlier quoted context omitted.

So what is the social function of Renaissance not paying $6B in taxes? How does this benefit society?

Renaissance did not avoid $6b in taxes. They never owned the stock in the baskets that the politicians claimed they did. The payout to risk ratio of the options is most likely why they were invested. There can't be a social function to not paying because there was nothing to pay.

I don't know specifically about Renaissance's case, but they may well have avoided $6B in taxes if a lot of their fees were categorized as "carried interest". (I don't think the particular fact that they invest in derivatives has anything to do with it.) For hedge funds any fees they accrue for "performance" are carried interest and not subject to regular income tax, though they will eventually be taxed at the capital gains rate. E.g., if a hedge fund charges 2% of assets annually, plus 20% of annual increases in asset value over 8%, the 2% fee would be taxed as regular income and the performance part (20% of increases > 8%) would accrue to them as carried interest, treated as capital gains.

You can read more about this at Wikipedia: http://en.wikipedia.org/wiki/Carried_interest

My not-so-informed belief is that while there may originally have been a decent rationale for treating hedge fund performance fees as carried interest, in many (most?) modern hedge fund scenarios that categorization is misapplied. In any case, the treatment as carried interest is legal, at least for now.

Re: What are hedge funds, and what social functions do they serve?

#84

Post by damoncali »

hsitz wrote: post #82
onetimeusename wrote: post #74

Earlier quoted context omitted.

Renaissance did not avoid $6b in taxes. They never owned the stock in the baskets that the politicians claimed they did. The payout to risk ratio of the options is most likely why they were invested. There can't be a social function to not paying because there was nothing to pay.

I don't know specifically about Renaissance's case, but they may well have avoided $6B in taxes if a lot of their fees were categorized as "carried interest". (I don't think the particular fact that they invest in derivatives has anything to do with it.) For hedge funds any fees they accrue for "performance" are carried interest and not subject to regular income tax, though they will eventually be taxed at the capita…

Those taxes are not avoided - it's just the current tax law. Money put at risk is taxed as capital gains. You don't automatically get carried interest - if you don't perform, it's zero.

Think of it as a portion of their salary that they are contractually bound to invest in the fund, with deference to the limited partners.

Do we really want to have fund managers without skin in their own funds? Carried interest is the only way to do that that does not favor the fantastically rich - who have enough advantages already. Ask yourself what might happen to the private fund industry (VC, PE, hedge funds, real estate, etc) if managers were not able to get carry. How would their compensation change? Which funds would benefit? Do we really want that?

Re: What are hedge funds, and what social functions do they serve?

#85

Post by goodside »

This really damages the credibility of the article:

"These investors must prove a certain net worth and go through a restrictive application process to become accredited."

In fact, there is no application process whatsoever. No organization "accredits" an accredited investor, and the SEC doesn't keep a list of who is and who isn't. If you satisfy the SEC definition, you simply are one: http://www.sec.gov/answers/accred.htm

Your status as an accredited investor is self-certified. If you go to a hedge fund with a sack of money and claim to be accredited, they'll take your word for it. All that the law requires is that they have a "reasonable belief" you're telling the truth. From SEC Release 33-6455:

"What constitutes 'reasonable belief' will depend on the facts of each particular case. For this reason, the staff generally will not be in a position to express views or otherwise endorse any one method for ascertaining whether an investor is accredited."

Re: What are hedge funds, and what social functions do they serve?

#86

Post by pjc50 »

damoncali wrote: post #53
yummyfajitas wrote: post #50

Earlier quoted context omitted.

The claim is that corporations will borrow money and use it to buy back shares. That's actually a nice hack - interest income is favorably treated relative to capital gains, so it's a way to turn a higher tax piece of capital (stock) into a lower tax piece of capital (bonds).

If it's advantageous to have more debt, then this is what you do. It's done by pretty much every company in the world, not just hedge funds. It's literally finance 101.

Advantageous for whom, though?

http://www.theguardian.com/money/2014/sep/22/phones-4u-closu...

My understanding is that phones4u was paying out dividends while increasing its debt; effectively an equity-for-debt swap. The difference is that this transfers risk from the owners to the creditors, allowing the business to collapse after it's been looted.

I think there's a case to be made for a rule "always pay your creditors before your equity investors" to avoid this kind of thing.

Re: What are hedge funds, and what social functions do they serve?

#87

Post by prostoalex »

lmg643 wrote: post #39

What social functions do hedge funds provide, indeed? Renaissance Technologies avoided $6bn in taxes by using derivatives to pretend their ultra-high frequency trading profits were actually long-term capital gains. http://www.bloomberg.com/news/2014-07-21/renaissance-avoided... Renaissance is one of the biggest and most successful hedge funds of all time. SAC was another of the most successful hedge funds of all time…

> If debt is priced too cheaply, HF will push companies to lever up to buyback stock. This is a socially useless form of activity, which increases business risk based on capital structure theory. Short term payoff, the debt will never go away.

Aren't stock repurchases generally a more tax-efficient vehicle for providing return to shareholders than dividends?

Also, why would the debt never go away? Companies usually raise debt by selling bonds with maturity dates.

Re: What are hedge funds, and what social functions do they serve?

#88

Post by Daishiman »

lmm wrote: post #75
lmg643 wrote: post #39

What social functions do hedge funds provide, indeed? Renaissance Technologies avoided $6bn in taxes by using derivatives to pretend their ultra-high frequency trading profits were actually long-term capital gains. http://www.bloomberg.com/news/2014-07-21/renaissance-avoided... Renaissance is one of the biggest and most successful hedge funds of all time. SAC was another of the most successful hedge funds of all time…

> Plenty of socially questionable legal strategies in HF land. Big one is stock buybacks - rational responses to Federal Reserve interest policies. If debt is priced too cheaply, HF will push companies to lever up to buyback stock. This is a socially useless form of activity, which increases business risk based on capital structure theory. Short term payoff, the debt will never go away. If it's useless then why does…

> If it's useless then why does it make them money?

Is that really a line of reasoning? I can make money by drug and arms trafficking, helping other skirt the law, take advantage of legal loopholes, using violence where competitors cannot to strongarm others into submission, exploiting labor, etc.

If a hedge fund makes its money just by being faster in transactions in a way that gives no real benefit to actual creators of value, then it is of no use to society.

Thus far, the argument for liquidity seems shoddy, at best.

Re: What are hedge funds, and what social functions do they serve?

#89

Post by Retric »

lmm wrote: post #75
lmg643 wrote: post #39

What social functions do hedge funds provide, indeed? Renaissance Technologies avoided $6bn in taxes by using derivatives to pretend their ultra-high frequency trading profits were actually long-term capital gains. http://www.bloomberg.com/news/2014-07-21/renaissance-avoided... Renaissance is one of the biggest and most successful hedge funds of all time. SAC was another of the most successful hedge funds of all time…

> Plenty of socially questionable legal strategies in HF land. Big one is stock buybacks - rational responses to Federal Reserve interest policies. If debt is priced too cheaply, HF will push companies to lever up to buyback stock. This is a socially useless form of activity, which increases business risk based on capital structure theory. Short term payoff, the debt will never go away. If it's useless then why does…

Because they also flease institional investors. While not talked about there are huge incentives for here funds to bribe money managers at pension funds etc. A hede fund managing 100 million that lost 50% of the money over 10 years makes well over 10 million, break even and there up 20 million.

Re: What are hedge funds, and what social functions do they serve?

#90

Post by [deleted] »

m52go wrote: post #73
simonster wrote: post #71

Earlier quoted context omitted.

Most moral wrongs are also social wrongs. Laws and regulations exist for the good of society, and flouting those laws is bad for the public good. If you pay less in taxes than you ought to, that means that the average citizen either pays more in taxes or doesn't get the social services those taxes would have paid for. Insider trading means that the insiders profit at the expense of the outsiders, who are typically fa…

> If you pay less in taxes than you ought to, that means that the average citizen either pays more in taxes or doesn't get the social services those taxes would have paid for. No, it means SOMEONE is paying more. That someone could be a rich person, another company, or a smorgasbord of other taxpayers. You can't assume it's Joe the Plumber who's paying more taxes (on average, because proportionally, corporations and…

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