Rich On Money

Hedge Fund Managers Before Congress

The highest paid profession in the world is that of hedge fund manager. Depending upon how good you manage the money, the average hedge fund charges its clients 2% per year on the money that it manages for expenses. On top of that, if there are gains in the portfolio than the hedge fund management team is incentivized to earn another 20% of the capital gains on the investable funds. Sometimes there is a caveat that the gains must exceed some predetermined barometer such as the labor rate of return, or the Treasury bill rate of return.

Take an example. If the fund manages a billion dollars which is not unusual these days and has a hot year, and makes 40% on the billion, there’s a $400 million increase in the portfolio. The management team would make $20 million for its expenses which is 2% on the $400 million. In addition, the management team would get 20% of $400 million or $80 million in capital gains to split up. Not a bad pay day, hey?

It gets better. If the clients’ gains are of a capital nature, than the compensation to the hedge fund is also considered to be a capital gain, taxed at a capital gain rate. It’s the best deal ever. These gains are called the carry.

Now the Democrats love to tax people. They should change their name from the Democratic Party to the Taxation Party. Now that I think about it, the entire Republican strategy this year should be to rename the Democratic Party as the Taxation Party in all their ads. The surprising thing to me is that Obama received tens of millions of dollars in support from the hedge fund kings and other similar professional types, and he now wants to tax them very heavily.

Obama’s objective is to change the nature of the income that the hedge fund manager receives from capital gain to ordinary income, or some hybrid treatment. The argument is that people who strive to invest are at risk for losses. The hedge fund manger as a rule does not put up his own money, but merely invests for others who are the ones AT RISK. If the hedge fund manager is not at risk, why should he receive capital gains treatment on his share of the gains? There is merit to the argument.

Now New York is about to scare away every hedge fund manager in the state with its proposed new tax laws. NYS is desperate to raise revenues. It is after all, among the most mismanaged states in the country, and has been for years. Allow me to prove it. NY spends about $40 plus billion per year on Medicaid expenditures for the poor. There are only 8 human beings who are examiners that audit the entire $40 plus billion. You are talking fraud on a scale amounting to billions and no one cares; only in New York. Taxation in NY is so bad, that the people who live there are use to being abused. They simply have no idea how superior life could be in other locations. They remain mesmerized that they are living the good life in NY. So here’s the latest deal.

The Governor wants to impose a special tax on hedge funds in order to raise $50 million. What will happen instead is that he will scare away people who are making hundreds of millions of dollars each, into the arms of Connecticut which is waiting for their arrival as we speak. Keep this in mind, 40% of the income tax revenues raised in New York State come from 1% of the tax base. Think about it, these people could live anywhere, any time. They chose to live in NY, and that can change on a dime.

Just last year, the state increased its top individual tax rate to almost 9% from 6.9%, and called it temporary. It will remain in effect at least through 2011. My experience is these types of taxes never get repealed once they get people use to paying them. This vey simply will drive more of the rich out of New York and into Connecticut. I live in Westport, Connecticut, and they will soon be my neighbors. Sometimes the good old days were better in some ways, but not always.

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