Hedge fund industry faces Darwinian future

Date: Tuesday, February 24, 2009
Author: Hedgeweek.com

Hedge fund managers have more problems on their plate than just the fragile state of the markets, predictions that investor redemptions will continue well into this year and facing up to the growing probability of greater regulation, at least in countries like the US where the flimsiness of oversight has become apparent over the past few months.

Now a ghost from more than a year ago is about to rear its head again. When new US president Barack Obama presents his first budget to Congress later this week, he is thought to envisage changes to the tax system that affect the carried interest or performance fee income of hedge and private equity fund general partners.

Obama is expected to propose that this income should be taxable at the 35 per cent maximum rate of income tax - which could rise to 39.6 percent under other measures envisaged to shore up the US government's tax take - instead of the 15 per cent tax rate levied on capital gains.

This is the revival of a proposal put forward before Congress in 2007, at a time when public concern about the supposedly exorbitant earnings of alternative fund managers was at its peak. The advocates of the proposal argued that that carried interest or performance fees of up to 20 per cent of profits were in fact income, and should be taxed as such, but the proposal failed to gain enough traction to win passage.

Now, as commentators note, the impact of such a change would hardly be felt by many alternative managers because the industry's profitability has temporarily collapsed. When it returns, however, it would significantly change the economics of the industry.

You can see why Antonio Borges, chairman of the Hedge Funds Standards Board, told the Committee of European Securities Regulators conference in Paris yesterday: 'For the future, it's very important to let the [hedge fund] model survive. It's a very Darwinian model where only the best survive.' Every new measure such as the proposed US tax change raises the bar for survival a little higher.