In all the debate about taxing "carried interest" as ordinary income, I haven't seen any discussion about how the payment is treated in the investor's books - does the investor simply pay capital gains on its earnings net of fees or does it pay (as I believe it should) capital gains on the gross earnings and deduct the fees as a business expense (saving 35%)?
Say, I invest $ 10 million in a hedge fund on terms of 2 and 20; say, it performs well and produces a gross return of 50% - this means that of the $ 5 million earned, I get 78%, or $ 3.9 million, while the manager gets $ 1.1 million
From first principles though, the tax calculation should be quite straightforward
Who owns the capital? Me
What is the total capital gain? $ 5 million
So, I should be taxed at 15% on this gain
What have I done to earn this money? I have employed a hedge fund and so the fees I should get a business expense deduction on the fees I pay
Thus, I would pay $ 750,000 in capital gains tax, $ 1.1 million in fees of which I could set off 35% (or $ 385,000) against my taxes - thus, my net post tax earning would be $ 3,535,000
Since the $ 1.1 million was a business expense in my hands, it must be business income in the hands of the earner - the fund's manager, who would earn $ 1.1 million and be taxed at 35%, for a net post-tax earning of $ 715,000.
The total take for the government would be $ 750,000, exactly equal to the 15% capital gains on the actual gains
Unless of course, as is likely, the goverment IS getting screwed since the investor is being taxed correctly and pays only (in our example) $ 365,000, while the fund manager pays (at 15% of $ 1.1 million) only $ 165,000. This would give a total tax revenue to the government of $ 530,000 on a capital gains of $ 5 million for an effective rate of just 10.6%.
If this is the case, it should be pretty open and shut since, as any tax lawyer would agree, a business expense in one hand (the investor) has to be business income (not capital gains) in the other
Surely it isn't this simple?
Friday, July 13, 2007
Monday, July 2, 2007
ARE WE THERE YET?
Globally, markets are, once again, getting very nervous. The sub-prime crisis in the US came to broad public attention a couple of weeks ago when Bear Stearns, one of the leading bulge bracket firms on Wall Street, had to unwind two of its mortgage-related hedge funds. The firm has already taken a bad hit on its last quarterly profits, and, with the process nowhere near finished, there’s certainly more to come. And, of course, nobody knows whether this is simply the tip of the hedge fund iceberg.
The big picture concern is that, as more and more US “hooker mortgages” go into default, there could be a domino effect on the huge collateralized debt obligation (CDO) market, with more and more market players, large and small, getting caught, which could lead to a serious bout of risk aversion, which, of course, could lead to a tumble in the price of a wide array of assets worldwide.
In response to this, the VIX index, a surrogate for risk aversion, shot higher to 18.89 last week, a shade short of the level it hit in March this year, when the first sharp fall in Chinese equities (this year) triggered a sudden bout worldwide nervousness, but way below the 45 level seen during the unwinding of the dotcom bubble. Thus, edgy thought the market is, risk is still quite cheap in historic terms, and, to be sure, the VIX has since dipped back to a more comfortable level.
US Treasuries, another key indicator of market sentiment, also slipped sharply, with June 13 seeing the largest one-day fall since 2004, with the 10-year bond yield climbing above 5.25% and breaking a long-term technical resistance. However, here, too, market has retraced some of its losses, but a lot of pundits remain on edge – some, very extravagantly so. I got a mail from an old friend, a very experienced US-based fund manager, who said, “Everyone (hedge funds, prop trading and technology-based firms in that space, discount brokerage firms and FCM's) are or have already gone public or ingested large sums of private equity within the past 6-12 months. As somewhat of a perpetual skeptic, I wonder why this activity is simultaneously occurring in all areas of our business, where astute traders who have made money for years are generously willing to let the public participate in the feast. Is it a market top of generational proportions or simply taking advantage of the unsatisfied demand for investment returns at any price …?”
A market top of generational proportions? Thems big words.
But, then, nickel has already fallen by over 30% – that’s right, 30% – since end-May, and in technical jargon may be in process of forming a frightening head and shoulders pattern, which, if triggered, could turn everything to dandruff. The volatility of the Euro is the lowest it has been since the Euro was first constituted in January 1999, suggesting some sort of breakout. Money supply in Japan has fallen below 100 trillion yen for the first time since mid-2000; as money supply tightens, demand for yen increases, which could put pressure on the gigantic volumes of the carry trade that has been (partly) fueling the vitality of financial markets in recent years. Clearly, there are several signs of a major shake out.
So, are we there yet? Is it time to pay the piper for these past few years of good times?
I don’t know.
But my sense is that we are not. There are far too many analysts predicting some sort of major collapse, and as we all know by now, one of the main jobs of financial markets is to prove the largest possible number of brilliant minds wrong. As Keynes famously said, the market can remain irrational a lot longer than you can remain solvent. I think the most correct interpretation of that is that rationality is not a natural state, which is why, time and again, the most astute – and rational – market analysts stumble long before the final hurdle, calling tops (or bottoms) months, sometimes years, before they actually occur.
Which is not to say that there won’t be any hiccups in asset prices. But, I don’t believe there will be any wide-ranging collapse, partly because the wide dispersion of risk created by the super-exponential growth of derivatives (and credit derivatives, in particular) will ensure that even large hiccups will be rapidly attenuated. But another, and to my mind, more important reason may be that global growth today is itself dispersed to a very micro level – the villages of India, for instance – where credit plays, at this stage, a relatively minor role.
So, even if another few hedge funds tumble, or if Chinese equities really correct, or if the yen surges to 115 on a serious unwinding of the carry trade, we may have a few weeks of risk aversion, but, in my view, these will all be buying opportunities.
India will, of course, respond to these signals, with both equities and the rupee likely to take a hit. However, despite the 8+ growth, which remains a certainty, the increasing failure of political governance – flooding in our international financial center, tarring of the office of the President, and, of course, continued sclerosis in deregulation – will, sooner or later, hit sentiment, exacerbating any volatility induced by global events.
The big picture concern is that, as more and more US “hooker mortgages” go into default, there could be a domino effect on the huge collateralized debt obligation (CDO) market, with more and more market players, large and small, getting caught, which could lead to a serious bout of risk aversion, which, of course, could lead to a tumble in the price of a wide array of assets worldwide.
In response to this, the VIX index, a surrogate for risk aversion, shot higher to 18.89 last week, a shade short of the level it hit in March this year, when the first sharp fall in Chinese equities (this year) triggered a sudden bout worldwide nervousness, but way below the 45 level seen during the unwinding of the dotcom bubble. Thus, edgy thought the market is, risk is still quite cheap in historic terms, and, to be sure, the VIX has since dipped back to a more comfortable level.
US Treasuries, another key indicator of market sentiment, also slipped sharply, with June 13 seeing the largest one-day fall since 2004, with the 10-year bond yield climbing above 5.25% and breaking a long-term technical resistance. However, here, too, market has retraced some of its losses, but a lot of pundits remain on edge – some, very extravagantly so. I got a mail from an old friend, a very experienced US-based fund manager, who said, “Everyone (hedge funds, prop trading and technology-based firms in that space, discount brokerage firms and FCM's) are or have already gone public or ingested large sums of private equity within the past 6-12 months. As somewhat of a perpetual skeptic, I wonder why this activity is simultaneously occurring in all areas of our business, where astute traders who have made money for years are generously willing to let the public participate in the feast. Is it a market top of generational proportions or simply taking advantage of the unsatisfied demand for investment returns at any price …?”
A market top of generational proportions? Thems big words.
But, then, nickel has already fallen by over 30% – that’s right, 30% – since end-May, and in technical jargon may be in process of forming a frightening head and shoulders pattern, which, if triggered, could turn everything to dandruff. The volatility of the Euro is the lowest it has been since the Euro was first constituted in January 1999, suggesting some sort of breakout. Money supply in Japan has fallen below 100 trillion yen for the first time since mid-2000; as money supply tightens, demand for yen increases, which could put pressure on the gigantic volumes of the carry trade that has been (partly) fueling the vitality of financial markets in recent years. Clearly, there are several signs of a major shake out.
So, are we there yet? Is it time to pay the piper for these past few years of good times?
I don’t know.
But my sense is that we are not. There are far too many analysts predicting some sort of major collapse, and as we all know by now, one of the main jobs of financial markets is to prove the largest possible number of brilliant minds wrong. As Keynes famously said, the market can remain irrational a lot longer than you can remain solvent. I think the most correct interpretation of that is that rationality is not a natural state, which is why, time and again, the most astute – and rational – market analysts stumble long before the final hurdle, calling tops (or bottoms) months, sometimes years, before they actually occur.
Which is not to say that there won’t be any hiccups in asset prices. But, I don’t believe there will be any wide-ranging collapse, partly because the wide dispersion of risk created by the super-exponential growth of derivatives (and credit derivatives, in particular) will ensure that even large hiccups will be rapidly attenuated. But another, and to my mind, more important reason may be that global growth today is itself dispersed to a very micro level – the villages of India, for instance – where credit plays, at this stage, a relatively minor role.
So, even if another few hedge funds tumble, or if Chinese equities really correct, or if the yen surges to 115 on a serious unwinding of the carry trade, we may have a few weeks of risk aversion, but, in my view, these will all be buying opportunities.
India will, of course, respond to these signals, with both equities and the rupee likely to take a hit. However, despite the 8+ growth, which remains a certainty, the increasing failure of political governance – flooding in our international financial center, tarring of the office of the President, and, of course, continued sclerosis in deregulation – will, sooner or later, hit sentiment, exacerbating any volatility induced by global events.
Friday, June 29, 2007
WHAT GOES AROUND COMES AROUND
I was startled a few weeks ago when I read an article by Martin Wolf, usually one of the soundest voices in the FT, more than concerned about the prospects of Rupert Murdoch and Newscorp taking over the Wall Street Journal - while Mr. Wolf was always a balanced voice in the debate about business and society, it seemed that his terror about the possible demise of one of the few well-articulated and balanced (???) voices of business journalism - Im paraphrasing, because I dont remember his exact words - seemed very unfair and judgmental of the New Barbarian
I was reminded of this yesterday when I saw a column by Paul Krugman of the New York Times, which was even more hysterical about the now-more-or-less-certain takeover - of course, Mr. Krugman, with whom I have agreed on a lot, is much more left wing, so his hysteria may be somewhat more understandble
But all in all, it is rather surprising that people who broadly subscribe to the market model of life should be horrified when in works against their tastes or interests
I hold no brief for Mr. Murdoch, except to note that he is a master of business - and I dont mean MBA - and, incidentally, a remarkably virile man, and I say more power to him and if the puny Wall Street Journal establishment is unable to withstand the assault from one of its very own free marketeers well - so much for hypcrisy
Again, it is rather remarkable that these liberal commentators view Mr. Murdoch distastefully relative to the WSJ - I read one issue of the WSJ recently after a long time and i was shocked at the near-fascist tone of a couple of its edit page articles - I couldnt believe there were people who believed the kinds of things they wrote and, equally importantly, that a supposedly reputable newspaper would publish that kind of stuff
Well, what goes around comes around
I was reminded of this yesterday when I saw a column by Paul Krugman of the New York Times, which was even more hysterical about the now-more-or-less-certain takeover - of course, Mr. Krugman, with whom I have agreed on a lot, is much more left wing, so his hysteria may be somewhat more understandble
But all in all, it is rather surprising that people who broadly subscribe to the market model of life should be horrified when in works against their tastes or interests
I hold no brief for Mr. Murdoch, except to note that he is a master of business - and I dont mean MBA - and, incidentally, a remarkably virile man, and I say more power to him and if the puny Wall Street Journal establishment is unable to withstand the assault from one of its very own free marketeers well - so much for hypcrisy
Again, it is rather remarkable that these liberal commentators view Mr. Murdoch distastefully relative to the WSJ - I read one issue of the WSJ recently after a long time and i was shocked at the near-fascist tone of a couple of its edit page articles - I couldnt believe there were people who believed the kinds of things they wrote and, equally importantly, that a supposedly reputable newspaper would publish that kind of stuff
Well, what goes around comes around
Saturday, June 23, 2007
THE DIFFERENCE BETWEEN INDIA AND CHINA
is not the difference between Mumbai and Shanghai or the differences in infrastructure or whatever - these are simply the effects of the real difference, which is that China is run by businessmen while India is run by politicians
It is hard to see that happening in India - some years ago I had told Anand Mahindra that he should enter politics, and he looked at me thoughtfully (but that was at Goa airport, so perhaps my powers of observation were colored), but we need somebody much more ruthless, like one of the Ambani boys (although Anil has been discolored by his recent liasons) or Subash Chandra, who has sparred with Rupert Murdoch - but they are probably all busy making more and more money and nothing wrong with that - perhaps Sunil Mittal hmmm...
It is hard to see that happening in India - some years ago I had told Anand Mahindra that he should enter politics, and he looked at me thoughtfully (but that was at Goa airport, so perhaps my powers of observation were colored), but we need somebody much more ruthless, like one of the Ambani boys (although Anil has been discolored by his recent liasons) or Subash Chandra, who has sparred with Rupert Murdoch - but they are probably all busy making more and more money and nothing wrong with that - perhaps Sunil Mittal hmmm...
Friday, June 22, 2007
THE NEXT US PRESIDENT
Michael Bloomberg, of course - looking for a bookie; since he hasnt even announced, it should be in the range of 50 to 1
Wednesday, June 20, 2007
TIME TRAVEL
jet lag is wonderful - when you're up, there's this amazing clarity, when you crash, you go into a deep sleep - perhaps its tending to the zero gravity experience - this then suggests that rather than trying to get over jet lag, we should try to prolong it - huh?
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