2008 Catches Up To Hedge Funds

Hedge fund managers already struggling with decreased interest due to sub-par performance over the past several years are now facing another struggle.

Grace period over

In 2008, lawmakers changed tax law to ensure those money managers who earned fees offshore and parked it in foreign accounts had to not only declare the money but also had to pay taxes on it. There was some temporary relief, however, as Congress gave the money managers until they filed their 2017 taxes to actually comply with the law.

While some hedge fund leaders complied immediately, others straggled into compliance over the past decade. There were are few however, who have waited as long as possible in order to benefit from tax-deferred compounding. They may also have been hoping that someone would figure out a clever tax loophole in the meantime. Unfortunately, no one has found a way around the 2008 rule as of yet.

While the waiting did help lower some of the tax bills, that was primarily due to lackluster earnings in recent years. Those lower earnings mean that some of the firms have suffered losses that offset their gains from prior years.

Withdrawing capital

According to Accounting Today, David Einhorn, John Paulsen, and Steve Cohen along with other managers cumulatively owed billions of dollars to the federal government. Greenlight Capital, Einhorn’s fund took between $200 million and $300 million out to pay taxes, estimated Bloomberg. Meanwhile, clients have withdrawn nearly $3 billion from Einhorn’s funds in the last two years.

Paulson, on the other hand, has been suffering from a loss of most of his clients following the financial crisis and has had to dip into his fund to pay the approximately $1.5 billion that he owed the IRS. Only 7 years ago, in 2011, Paulson managed $38 billion, with about half of that amount being his own fortune due to his successful investment in sub-prime mortgages. Since that time, he’s been less lucky, making unlucky investments in gold, U.S. banks, and pharmaceutical companies that have failed to perform. He’s now managing only around $9 billion, most of which is his own.

A failing industry

It’s always painful for a fund to sacrifice assets, but these sacrifices have come at an even more difficult time for fund managers. There simply isn’t the same interest in hedge fund investment that there once was. In fact, in 2017 only $9.8 billion came into hedge funds. That’s only a small piece of the $3.2 trillion in assets throughout the industry.

Some success

There are some hedge fund success stories, however, as Cohen has been able to replace the money withdrawn from his fund for taxes. He withdrew nearly $3 billion from Point72 Asset Management to pay the IRS, but he’s also raised about that much earlier this year. The firm just opened to outside clients following a Securities and Exchange Commission suspension. Cohen pleaded guilty to securities fraud and paid a significant fine in 2013 in relation to his prior firm, SAC Capital Advisors.

Another successful fund, Perceptive Advisors has posted annualized returns of about 30 percent since it began in 1999. Run by Joe Edelman, the firm is billed as a biotech hedge fund and could use the $500 million recently raised from clients to pay taxes.

The bottom line here is that the grace period for hedge fund owners who park cash outside the country is at an end, and the federal government will continue to see more tax money returning to the United States.