random thoughts
-much of the finance industry is self serving
-as competition grows and/or returns are consistently lower than index funds, the 2/20 fees should come down. if not, then something is not working properly
What are hedge funds, and what social functions do they serve?
101–110 of 122 posts
Re: What are hedge funds, and what social functions do they serve?
#102What 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…
There was no dishonest or misleading tactic that Renaissance tech used. They held on to options and used that legal tax structure. Options for a basket of stocks and the basket of stocks themselves are completely different things and have different risks and payouts. That they are using derivatives to avoid taxes is just drama that politicians are inventing.
Did you read the complaint?
"The facts indicate that the basket option structures examined in this investigation were devised by sophisticated financial firms to allow clients to circumvent federal taxes and leverage limits. The structures rested on two fictions. The first was that the bank, rather than the hedge fund, owned the assets being traded in the designated option accounts, even though the hedge fund bought and sold the assets, was exposed to all significant risks and rewards, and profited from the trading, with little input from the bank serving as the nominal owner of the assets. In effect, the structure purported to enable the hedge fund to purchase an “option” on its own trading activity, an arrangement that makes no economic sense outside of an effort to bypass federal taxes and leverage limits. The second fiction was that the profits from the trades controlled by the hedge fund could be treated as long-term capital gains, even for trades lasting seconds. That fiction depended upon the hedge fund claiming that the profits came from exercising the “option” rather than from executing the underlying trades. In fact, the “option” functioned as little more than a fictional derivative, permitting the hedge fund to cast short-term capital gains as long-term gains and authorizing financing at levels otherwise legally barred for a customer’s U.S. brokerage account."
So the complaint is that this was fictional derivatives used to mask ownership of the underlying assets and thereby avoid taxes. I'm going to do some more research but it does sound shady.
Earlier, the complaint points out that the IRS has already identified this as abusive behavior but has not acted:
"While that type of option product was identified as abusive in a public memorandum by the Internal Revenue Service (IRS) in 2010, taxes have yet to be collected on many of the basket option transactions and its use to circumvent federal leverage limits has yet to be analyzed or halted."
Re: What are hedge funds, and what social functions do they serve?
#103What 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…
The social function of hedge funds is to provide the expected returns for their given investor (examples: uncorrelated returns to the S&P500, downside protection, returns generated by non-stock/bond investments, et al) - the same as any investment vehicle. Those returns should then be accrued to the investors in a given fund, thereby enabling things like pensions as well as non-retirement gains.
Now, I don't believe this is what they provide, but I'm trying to answer your question.
Re: What are hedge funds, and what social functions do they serve?
#104Earlier quoted context omitted.
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…
It's not an issue of whether someone should get carried interest - it's an issue of the rate at which that carried interest is taxed.
Funds are essentially providing a service for a given investor but getting taxed as though it was all their own money in the fund - which is not the case in most funds.
Instead, what the funds are doing is essentially providing investment advice - for which the fees should be taxed at normal rates rather than at the carried rate as though it is all their own money.
So I have no issue with the manager getting carried interest or being taxed at lower rates on their own money - but when they take money from outside investors, they should be taxed at normal rates.
Re: What are hedge funds, and what social functions do they serve?
#105Earlier quoted context omitted.
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…
It's not an issue of whether someone should get carried interest - it's an issue of the rate at which that carried interest is taxed. Funds are essentially providing a service for a given investor but getting taxed as though it was all their own money in the fund - which is not the case in most funds. Instead, what the funds are doing is essentially providing investment advice - for which the fees should be taxed at…
I won't argue that our tax code is anything but ridiculous. But treating carried interest and capital gains the same way makes sense - it's money put at risk as an investment. I don't think it's relevant that in one case cash is risked and in another case it's compensation at risk. Nobody is goign to argue that the management fee is capital gains because it isn't - it's guaranteed cash. It's different.
I think you can argue that capital gains shouldn't be taxed differently than income at all (not sure what I think of that, honestly), but if carried interest has to be in either the "income" bucket or the "gains" bucket, it looks more like gains to me.
Re: What are hedge funds, and what social functions do they serve?
#106Earlier quoted context omitted.
Geez we all enjoy the benefits of the 2008 financial crisis. Society was never happier.
That was almost entirely caused by an institution known as the BANK. Banks and hedge funds are totally different things. Likening one to the other is like saying Google and Square are both evil just because they're technology companies. You seem to lack a fundamental understanding of the financial system.
Oh really? So in your dictionary AIG is a bank, like say BoA. You seem like having a deep understanding of the financial system. Don't forget to edit the wikipedia page, these guys got it all wrong[2] oh yes the WSJ[1] too!
[1] http://online.wsj.com/articles/SB123734123180365061
[2] http://en.wikipedia.org/wiki/American_International_Group#Li...
Re: What are hedge funds, and what social functions do they serve?
#107Earlier quoted context omitted.
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…
"Money put at risk is taxed as capital gains." Huh? Money that hedge fund owners provide as fund capital is already theirs, they don't pay tax on it at all. Of course gains in value of their capital investment are taxed as capital gains. But the performance fees we're talking about are fees that accrue to hedge fund managers from managing _other people's money_, not the capital gains that manager's realize directly as the increase in value of their own investment.
If hedge fund managers could not performance fees categorized as carried interest they'd pay regular income tax rates on them. Not sure how that changes their management of the funds. Presumably if they believe they're the best managers out there they'll want to have their own assets in their fund (and of course will pay only capital gains tax on increases in value of their assets). By the way, high percentage of hedge fund managers are already among the "fantastically rich". . . .
Re: What are hedge funds, and what social functions do they serve?
#108Earlier quoted context omitted.
> 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 creato…
> 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.
By and large you can't, which is the point. We don't stop these things by appealing to people's better natures. We stop these things by making them unprofitable. When hedge funds misbehave it's usually a symptom, not a cause.
Re: What are hedge funds, and what social functions do they serve?
#109If you're interested in reading some more about the collapse of LTCM, I recommend When Genius Failed by Roger Lowenstein (for a fuller appreciation, read Liar's Poker by Michael Lewis first). If you're interested in reading an excellent account of a startup HFT/hedge fund, it's worth ordering a secondhand copy of The Predictors by Thomas Bass (for a fuller appreciation, read Chaos by James Gleick first).
_When Genius Failed_ is a freaking fantastic book; even after the 2008 crisis, still one of the all-time best pieces of financial narrative journalism ever. I'm not sure _Liar's Poker_ sets it up that well. Go ahead and read Lowenstein first. In fact, it might even work better the other way around, because Lewis' narrative is really fragmented and Lowenstein's isn't.
Liar's Poker includes an anecdote about how John Gutfreund (CEO of Salomon Bros) challenged a bond trader called John Meriwether to a high-stakes game of Liar's Poker: "One hand. One Millions dollars. No tears."
John Meriwether went on to found LTCM. Liar's Poker provides some of the background and context for the story Lowenstein tells in When Genius Failed.
Re: What are hedge funds, and what social functions do they serve?
#110Earlier quoted context omitted.
It's not an issue of whether someone should get carried interest - it's an issue of the rate at which that carried interest is taxed. Funds are essentially providing a service for a given investor but getting taxed as though it was all their own money in the fund - which is not the case in most funds. Instead, what the funds are doing is essentially providing investment advice - for which the fees should be taxed at…
I won't argue that our tax code is anything but ridiculous. But treating carried interest and capital gains the same way makes sense - it's money put at risk as an investment. I don't think it's relevant that in one case cash is risked and in another case it's compensation at risk. Nobody is goign to argue that the management fee is capital gains because it isn't - it's guaranteed cash. It's different. I think you ca…
"I think you can argue that capital gains shouldn't be taxed differently than income at all (not sure what I think of that, honestly), but if carried interest has to be in either the "income" bucket or the "gains" bucket, it looks more like gains to me."
Looks more like income to me - fees paid to people for managing money that they themselves have not put at risk.