Through The Fly's Eyes: U.S. Congress & hedge funds

from Joseph Lazzaro of Theflyonthewall.com















House Hedge Fund Tax Seen Hitting Incomes, Not Capital Flows

The initial, preliminary evaluation late Monday of U.S. House Democrats' proposal to increase the tax rate on managers of hedge funds was that it, "probably would not have as chilling an effect on talent or the industry as one might think."

At least that was the initial evaluation of one experienced, New York-based hedge fund sector professional, who spoke on condition that he not be identified by name.

The professional, a 10-year hedge fund pro, said, "No one likes the prospect of paying [substantially] higher taxes," but added that, in his interpretation, the House Democrats' proposal would not drive away talent, because the sector has many preferred qualities that managers like and that won't go away if the Democrats' proposal becomes law.

The source then listed numerous investment strategies managers use at hedge funds that are simply not allowed in other investment venues, for example, at mutual funds.

Managers who take a share of hedge fund and private-equity fund profits pay taxes at a 15% rate, the rate for capital gains. The Democrats bill would raise the rate levied on their compensation, known as "carried interest," to 35%, the level for income tax.

House Democrats introduced their bill on the heels of The Blackstone Group's (BX) IPO, a $4 billion initial public offering, the sixth-richest IPO in U.S. history.

Critics of the bill also argue that the bill could also slow funds into hedge funds and private equity funds, and they say this would undermine a sector that has strengthend and helped make more competitive companies - large, medium, and small. However to-date, no multivariable, longitudinal study exists to confirm the above, which plays into the bill's proponents' argument that the 15% tax rate for hedge fund and private equity managers represents a double standard.

Still, a higher tax rate would not substantially alter the secular hedge fund / private equity trend that's seen the sector amass more than $1.3 trillion in assets and hundreds of talented fund managers, the hedge fund source said. That's because hedge funds, "offer the freedom to deploy many more investing and trading strategies, over longer periods of time" than other environments, adding it is that operational flexibility and freedom that is giving investors what they seek: the chance to achieve massive returns that are not possible in most other asset classes.

While qualifying his remarks by stating, "We're early in the hedge fund game," the source underscored that it is that factor - freedom / flexibility - that will continue to lure talent to the sector, even if the tax rate is raised substantially: higher taxes "hurt, but they don't wipe out the sector's appeal, from a manager standpoint." And as long as the freedom and talent is there, "the high returns will follow, and so will the capital flows," he added.