Fri, 13/06/2008 - 06:59
Efforts in the US Congress to change the tax treatment of hedge fund managers and private equity firms may have been halted last year, but they have not gone away. The latest salvo, which targeted the use by hedge fund managers of offshore centres to defer compensation, and thus its taxation, was narrowly blocked this week, but fresh initiatives may be in prospect once a new president and congress are elected in November. One consolation for the alternative investment industry, however, is that it has found allies recently in past critics such as the Securities and Exchange Commission and Germany's Social Democrat ministers.
Proposed legislation that would strike at the very heart of the deferred compensation enjoyed by many hedge fund managers has been resurrected on Capitol Hill. Legislation that came close to passing the Senate on Tuesday sought to alter US tax policy so that hedge fund managers using offshore tax havens would no longer be able to defer taxes on their compensation, obliging them to pay taxes immediately on this income.
However the legislation, which analysts estimated would have raised USD24bn over 10 years had it been passed by the Senate on Tuesday, was blocked in the end - just.
The Managed Funds Association, a US-based hedge fund lobbying group that has vowed to fight the provision, said in a letter last month that without access to the offshore funds of US managers, foreign investors were likely to flock to funds and managers elsewhere, potentially denying their capital to US markets.
Had the proposed legislation been passed, it would have certainly have come at the wrong time. Most of the hedge fund industry would assert that an end to tax deferment would stifle investment and hurt the liquidity that hedge funds provide to the markets.
Attacking the hedge fund community, which has been one of the most reliable sources of market liquidity during the current credit crisis, could have precipitated an economic backlash.
Hedge fund managers are safe for now, but with US elections looming, the country's hedge fund community will be awaiting the outcome on the edge of their seats.
Are investors happy with all aspects of the current regulatory arrangements for the alternative investment industry? As usual, some are and some are not. Hedge funds, which have a reputation for being secretive, have been called upon to increase transparency. But how much information do hedge funds divulge by comparison with other types of alternative investment?
Apparently, they report more frequently than any of the other funds in the category, according to an extensive survey of hedge funds, private equity, real estate, infrastructure and commodity funds released last month by PricewaterhouseCoopers, entitled Transparency versus Returns: the Institutional Investor View of Alternative Assets.
The report indicates that more hedge fund managers report to clients daily, weekly or monthly than managers in almost any other alternative investment category. For example, 85 per cent of hedge fund managers surveyed by PwC said they reported to investors at least monthly, compared with 43 per cent for private equity funds, 42 per cent for real estate funds, 36 per cent for infrastructure funds and 64 per cent for commodity funds.
So why are hedge funds being hounded when, in fact, they report more frequently than their alternative investment peers? The answer perhaps lies in the attitudes of investors and other observers, and how the media can influence people's opinions.
You know that hedge funds have met their ultimate test when they take a wager against the world's richest man, one whose fortune has been built upon investment strategy. So when a fund of hedge funds manager enters into a bet for an amount expected to be about USD1m with Warren Buffett, he had better be confident about the result.
What is the bet? It is whether or not funds handpicked by experts can beat the S&P 500 index over 10 years. The issue is whether investors' returns from hedge funds can beat a passive index strategy over the long term despite the hefty fees levied by their managers.
Many managers, including New York-based fund of hedge funds manager Protégé Partners, which has taken up Buffett's challenge, believe that good hedge fund managers are worth their fees because they can deliver positive returns in all kinds of markets.
There is some USD640,000 in the kitty, half put up by Buffett and half by Protégé Partners. At the end of 10 years the pool, expected by then to be worth around USD1m, will go to a charity of the winner's choice. The bet has underway since the beginning of this year.
Protégé principal Ted Seides joked to Fortune magazine: 'Fortunately for us, we're betting against the S&P's performance, not Buffett's.' Time will tell who will win, but 10 years down the line, the result could be a telling public verdict on hedge funds and their performance.
Remember the Securities and Exchange Commission, which had vowed to continue pushing for tougher regulation for hedge funds despite the courts rejecting as illegitimate rules the US financial regulator introduced requiring the registration of hedge fund managers?
Now the SEC has sided with activist hedge fund firm The Children's Investment Fund Management in its legal dispute with US railway operator CSX over the requirements on investors to disclose the stakes they hold in companies.
The railroad has sued TCI and another hedge fund, 3G Capital Partners, alleging that they illegally used equity swaps to mask their stakes in the company and evade disclosure rules. However, the SEC has rejected CSX's argument, saying it believes that a swaps stake is 'not sufficient to create beneficial ownership'.
And how about the locust call? In 2005, Franz Müntefering, then chairman of Germany's ruling Social Democratic party, accused private equity firms of behaving like 'locusts.' At that time, TPG's 50 per cent ownership of sanitary fittings manufacturer Grohe was a major focus of German criticism of private equity investment.
Today Grohe is so successful that the German government, a coalition that includes the Social Democrats, is again citing it as an example - but this time of how private equity companies can boost growth and turn companies around. In bad times, even foes can become friends - especially if they are astute.
As the global economy undergoes a structural shift to find its new level in the wake of the liquidity crisis, and as developing economies pick up the pace while markets in the West falter, large hedge fund managers are seeking the best opportunities - and these opportunities seems to be in Asia.
These managers, somewhat more dynamic investors than the traditional investment firms, have been eyeing Asian opportunities for some time. For example, Blackstone's newly-established Altius Advisors business is reported to be launching its inaugural standalone Asia fund in October.
Hong Kong-based Altius is understood to be seeking to raise between USD500m and USD1bn for the fund, which will seek returns from investment in Asian companies involved in M&A, bankruptcies and restructurings.
It's not only Blackstone that is showing interest in Asia. Tribridge Investment Partners and HSBC Halbis Capital Management have unveiled plans for new hedge funds, while ADM Capital plans to raise almost USD1bn for existing funds. KGR Capital has also indicated that it is mulling a launch and fundraising drive.
A recent Deutsche Bank survey said that cash levels among hedge funds are high as investors take a 'wait and see' approach. For some at least, the wait now seems to be ending.
The United Nations Joint Staff Pension Fund, which manages USD40.6bn worth of assets, still does not have any allocation to alternative investment, more than a year after advisers recommended investing in private equity and hedge funds, according to media reports.
At the end of March, the fund held 57 per cent of its assets in equities, 36.8 per cent in bonds, 1.8 per cent in property and 4.4 per cent in cash. In April last year, the US firms Pension Consulting Alliance and EFI Actuaries compiled a report for the pension fund that recommended allocating up to 6 per cent of its assets in alternatives, although they noted that investing in these asset classes would require significant resource and procedural adjustments from the fund itself.
The lack of response from the UN fund is surprising, as these investment classes are easily accessible and available. However, there are signs that the UN fund may take a step towards alternative investment. Media reports earlier this year indicated that the pension fund had requested help from external investment consultants on alternatives.
Over the first quarter of the year, the fund suffered negative returns of 2.7 per cent. Perhaps now would be a good time for the fund to speed up its research.
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