Are Hedge Funds Best Days in the Rear View Mirror?

After reading some of the articles published in response to the SALT Conference sponsored by Skybridge CEO, Anthony Scaramucci, one might be persuaded that this is the case. However, the authors of these doom and gloom pieces fail to recognize the resilience baked into the hedge fund industry by virtue of the innovative and entrepreneurial spirit of hedge fund founders.

What is undeniable, are the relentless attacks from the remaining candidates of both political parties directed broadly toward the über-wealthy and specifically toward hedge fund founders. Each of these candidates, in their own way, wishes to right perceived wrongs with regard to the rates at which these fund managers are taxed.

Change Is Inevitable

As a practical matter, one of these individuals will be the next President of the United States. Whether it is Hillary Clinton, Bernie Sanders or Donald Trump, demands for reforms in the tax law will be put forward…changes that will not bode well for the one percent in general and hedge fund managers in particular. However, to suggest that hedge funds will no longer play a major role in the financial system is ludicrous.

Carried interest is the principal target of the proposed reforms and, as a practical matter, has been the subject of debate long before this election cycle. This provision, which taxes specific investment income as a capital gain rather than ordinary income, is an undeniable, but completely justifiable, perk.

That said…its days are very likely numbered in this populist, political climate.

Among the topics of renewed discussion are hedge fund fees. It is amusing that a preponderance of those in the financial media continue to reference 2 and 20 management and performance fees as if they were the industry standard. These days, very few hedge fund firms can negotiate a 2 and 20 fee structure with an investor.

Hedge Fund Jobs

No reasonable person will deny that eliminating carried interest will have an impact on hedge funds. And yes, the impact will reach beyond the founder. Upside sharing is a common practice in the industry. According to the 2016 Hedge Fund Compensation Report, twenty-five percent of hedge fund employees receive an equity share. This upside or equity sharing is a function of carried interest.

What many do not recognize, is that 13 percent of the 25 percent who receive an equity share actually get less than 2 percent. Only 6 percent of the 25 percent receive 11 percent or more. In short, it is a very select group within the fund that reap the benefits of carried interest.

Will this select group bemoan its loss? Absolutely! Will it signal the demise of hedge funds? Certainly not!

More to the point, hedge fund professionals just entering the firm, and those with only a few years under their belts, are unlikely to be among the 25 percent receiving this perk. In this regard, the elimination of the carried interest provision is a non-event for 75 percent of hedge fund professionals.

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