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

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

#111

Post by tptacek »

jackgavigan wrote: post #109
tptacek wrote: post #43

Earlier quoted context omitted.

_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 .

Sure, I know that, but my point is that the LTCM story is actually easier to follow than Liar's Poker, and knowing who the characters are coming in to LP makes it easier to follow. There's really nothing in Lewis' book that explains anything about LTCM, but there's stuff in WGF that shines a light on some minor characters in LP.

Read When Genius Failed first.

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

#112

Post by damoncali »

inthewoods wrote: post #110
damoncali wrote: post #105

Earlier quoted context omitted.

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.

But they have put it at risk. You don't think they'd demand (and get) more salary if they didn't get carried interest?

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

#113

Post by inthewoods »

damoncali wrote: post #112
inthewoods wrote: post #110

Earlier quoted context omitted.

"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.

But they have put it at risk. You don't think they'd demand (and get) more salary if they didn't get carried interest?

Again, we're not talking about getting carried interest - we're talking about the taxes on that carried interest. They put the capital at risk, but this is no different than any fee-based service, thus it is income rather long term capital gains.

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

#114

Post by jackgavigan »

tptacek wrote: post #111
jackgavigan wrote: post #109

Earlier quoted context omitted.

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 .

Sure, I know that, but my point is that the LTCM story is actually easier to follow than Liar's Poker, and knowing who the characters are coming in to LP makes it easier to follow. There's really nothing in Lewis' book that explains anything about LTCM, but there's stuff in WGF that shines a light on some minor characters in LP. Read When Genius Failed first.

I'm not talking about just the characters. I'm talking about background and context.

You clearly disagree, which you're perfectly entitled to do.

For everyone else: I've worked in the financial markets for over a decade, I'm an ex-trader who used to deal with hedge funds like (and including) George Soros's Quantum Fund. My advice is to read Liar's Poker first.

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

#115

Post by tptacek »

jackgavigan wrote: post #114
tptacek wrote: post #111

Earlier quoted context omitted.

Sure, I know that, but my point is that the LTCM story is actually easier to follow than Liar's Poker, and knowing who the characters are coming in to LP makes it easier to follow. There's really nothing in Lewis' book that explains anything about LTCM, but there's stuff in WGF that shines a light on some minor characters in LP. Read When Genius Failed first.

I'm not talking about just the characters. I'm talking about background and context. You clearly disagree, which you're perfectly entitled to do. For everyone else: I've worked in the financial markets for over a decade, I'm an ex-trader who used to deal with hedge funds like (and including) George Soros's Quantum Fund. My advice is to read Liar's Poker first.

You have me curious now. What's some of the background and context from Liar's Poker that's valuable for reading When Genius Failed?

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

#116

Post by damoncali »

inthewoods wrote: post #113
damoncali wrote: post #112

Earlier quoted context omitted.

But they have put it at risk. You don't think they'd demand (and get) more salary if they didn't get carried interest?

Again, we're not talking about getting carried interest - we're talking about the taxes on that carried interest. They put the capital at risk, but this is no different than any fee-based service, thus it is income rather long term capital gains.

If they took part of their salary and opted (or were required by LP's) to invest that money in their fund, should any gains there be taxed as capital gains or ordinary income? They would clearly be capital gains.

What is the difference between that and carried interest? The only thing I can think of is that it's not taxed as ordinary income before being invested, which is a fair criticism. On the other hand, you don't get a tax benefit if you lose that money in the CI case (which happens a lot), so it balances out at least to a degree.

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

#117

Post by inthewoods »

damoncali wrote: post #116
inthewoods wrote: post #113

Earlier quoted context omitted.

Again, we're not talking about getting carried interest - we're talking about the taxes on that carried interest. They put the capital at risk, but this is no different than any fee-based service, thus it is income rather long term capital gains.

If they took part of their salary and opted (or were required by LP's) to invest that money in their fund, should any gains there be taxed as capital gains or ordinary income? They would clearly be capital gains. What is the difference between that and carried interest? The only thing I can think of is that it's not taxed as ordinary income before being invested, which is a fair criticism. On the other hand, you don'…

I'd have no issue with their own investments in the fund being taxed as long term capital provided they have held the investment for a year when the profit is taken.

Here's a simple way to think about it - an ordinary RIA invests money on behalf of their clients. The fees they get for that service are taxed as ordinary income. Why should carried interest be any different when the money is coming from clients? And why should carried interest be taxed at a lower rate regardless of hold time? The simple answer is that these fees aren't any different - and therefore should be taxed at the same rate in my opinion.

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

#118

Post by damoncali »

inthewoods wrote: post #117
damoncali wrote: post #116

Earlier quoted context omitted.

If they took part of their salary and opted (or were required by LP's) to invest that money in their fund, should any gains there be taxed as capital gains or ordinary income? They would clearly be capital gains. What is the difference between that and carried interest? The only thing I can think of is that it's not taxed as ordinary income before being invested, which is a fair criticism. On the other hand, you don'…

I'd have no issue with their own investments in the fund being taxed as long term capital provided they have held the investment for a year when the profit is taken. Here's a simple way to think about it - an ordinary RIA invests money on behalf of their clients. The fees they get for that service are taxed as ordinary income. Why should carried interest be any different when the money is coming from clients? And why…

Because the fees charged by the mutual fund guys are fixed - it's a straight percentage of assets. Just like the fees charged by hedge funds which are taxed as ordinary income.

To take it a step further, should entrepreneurs pay ordinary income tax on their gains when they sell their company if they didn't invest any of their own money? It's the same thing. Carried interest is just a fancy name for sweat equity.

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

#119

Post by inthewoods »

damoncali wrote: post #116
inthewoods wrote: post #113

Earlier quoted context omitted.

Again, we're not talking about getting carried interest - we're talking about the taxes on that carried interest. They put the capital at risk, but this is no different than any fee-based service, thus it is income rather long term capital gains.

If they took part of their salary and opted (or were required by LP's) to invest that money in their fund, should any gains there be taxed as capital gains or ordinary income? They would clearly be capital gains. What is the difference between that and carried interest? The only thing I can think of is that it's not taxed as ordinary income before being invested, which is a fair criticism. On the other hand, you don'…

Replying here because of HN limitation:

"Because the fees charged by the mutual fund guys are fixed - it's a straight percentage of assets. Just like the fees charged by hedge funds which are taxed as ordinary income."

Taxable methodology isn't generally determined by the way you earn your income. The concept of long term capital gains was created to reward investors (those who invest their own capital) who hold capital in a given investment vehicle for over a year, not for whether or not they are taking on risk, or whether they are paid out based on a fixed fee or fixed percentage of profit. We don't tax waiters at a different rate for the money they get on tips (sweat equity) vs. their base salary.

Fees charged by private equity are also fixed - they are a fixed percentage of profit. So again, I don't see why this is any different. We have an investment vehicle taking in money, making investment decisions on the behalf of their investors and then making a percentage of the profits - all normal activities - nothing that warrants special tax treatment.

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

#120

Post by dragonwriter »

inthewoods wrote: post #119
damoncali wrote: post #116

Earlier quoted context omitted.

If they took part of their salary and opted (or were required by LP's) to invest that money in their fund, should any gains there be taxed as capital gains or ordinary income? They would clearly be capital gains. What is the difference between that and carried interest? The only thing I can think of is that it's not taxed as ordinary income before being invested, which is a fair criticism. On the other hand, you don'…

Replying here because of HN limitation: "Because the fees charged by the mutual fund guys are fixed - it's a straight percentage of assets. Just like the fees charged by hedge funds which are taxed as ordinary income." Taxable methodology isn't generally determined by the way you earn your income. The concept of long term capital gains was created to reward investors (those who invest their own capital) who hold capi…

> Taxable methodology isn't generally determined by the way you earn your income. The concept of long term capital gains was created to reward investors (those who invest their own capital) who hold capital in a given investment vehicle for over a year, not for whether or not they are taking on risk, or whether they are paid out based on a fixed fee or fixed percentage of profit.

There's a pretty good argument that some special treatment of income from long-term holdings (or, at least, something that accounts for them) is necessary in a system with progressive taxes on annual income, because otherwise small investors with infrequent realizations of income from long-term holdings would be taxed more on their income (on average) than people with the same average annual income who made constant income year-to-year.

OTOH, one can argue that the particular mechanism of long-term capital gains is a bad mechanism for that because it doesn't account for similarly irregular non-capital income (e.g., a writer whose income is mainly royalties that are concentrated immediately after new book releases who infrequently releases books that are bestsellers, but with several years of minimal income in between) and, at the same time, undertaxes capitalists that can afford enough in long-term holdings that rotate to realize constantly high income from long-term holdings.

Things like hedge funds and carried interest are sort of nibbling around the edges.

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