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What are the tax implications of becoming a limited partner/investor in a hedge fund?? |
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What kind of fees do most hedge funds charge? |
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Can an accredited investor place IRA or ERISA assets in a hedge fund? |
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Are hedge fund returns reported before or after fees? |
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What are the applicable securities laws for hedge funds? |
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What are the limitations on compensation to the General Partner? |
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What are the tax implications of becoming a limited partner/investor in a hedge fund? |
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At the end of each year a Hedge Fund as a limited partnership reports in a K-1 form gains or losses for the trades the fund made that year. These gains or loses are treated as are any other capital gain. It is important to note that the return of a fund is separate from the taxable gains and losses the fund has made over the course of the year. For example, it is possible that a fund may have "realized" a loss for tax purposes but have reported positive performance (capital appreciation) through unrealized gains. The opposite is also possible. |
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What kind of fees do most hedge funds charge? |
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The majority of U.S. hedge funds charge the standard "one-and-twenty": 1% of assets and 20% of profits, annually (more precisely, the 1% fee is usually charged in .25% increments quarterly, in advance while the 20% is usually calculated annually). These are known as the "management fee" and "performance fee" respectively. There are many variations and embellishments, some fairly common. For instance, most funds observe a "high-water mark". This simply means that if, in a given performance fee period, a fund loses part of its investor's money; the investors will not be charged in later periods until the losses have been recovered. Another common variation is the "preferred return." This means that a fund will not collect a performance fee until a certain return is achieved. This is often fixed, say at 10%, or 'floats' along with some risk-free interest rate indicator.
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Can an accredited investor place IRA or ERISA assets in a hedge fund? |
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Usually accredited investors may invest IRA or ERISA assets in hedge funds; however, funds are limited in the amount of these assets they may accept. IRA investments in hedge funds makes a great deal of sense because of the deferral of taxes on capital gains. The details of this deferral should be discussed with an accountant before making an investment. |
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Are hedge fund returns reported before or after fees? |
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Most funds report their returns from previous years "net of all fees." This means net of management fees and net of incentive/performance fees. However, don't assume this; look carefully and if you are not sure, ask. Some funds report gross returns or returns net of management fees but gross of incentive /performance fees. Still others will report audited net of all fees returns with estimated/pre-audited net of all fees performance for the current year's performance. But regardless of which method is used, almost all funds state that their pre-audit figures are subject to adjustment by the partnership's auditor after the end of the year. These adjustments are almost always minor. If the adjustments are large, you should look for an awfully good explanation. |
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What are the applicable securities laws for hedge funds? |
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Historically, the offer and sale of securities within the United States has been subject to
concurrent federal and state regulation under the Securities Act of 1933 (the “Securities Act”) and
state blue-sky laws. In order to avoid the registration and prospectus delivery requirements of the
Securities Act, securities of hedge funds and offshore funds are typically offered in private
placement transactions which rely on the private placement “safe harbor” provisions of Regulation D
or the safe harbor for offerings outside the United States contained in Regulation S. Until the
passage of a recent law, however, a separate exemption from state registration or qualification
requirements needed to be perfected under the blue-sky law of each state where the securities were
offered. Pursuant to recent legislation, states are prohibited from imposing their blue-sky laws
relating to registration or qualification of securities with respect to securities offered in a
private placement pursuant to Rule 506 of Regulation D. States are still permitted to require notice
filings that are similar to the Form D that is filed with the SEC pursuant to Regulation D, and to
collect filing fees. The new law prohibits states from regulating the content of offering documents
or the terms of securities being offered. Certain states may regulate general partners and their
employees (if applicable) as brokers and require certain filings under their broker-dealer regulatory
schemes prior to the offer of any securities in their jurisdictions. These filings can be burdensome
and time consuming. |
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What are the limitations on compensation to the General Partner? |
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There is usually a loss carry forward provision which carries forward any losses previously allocated to a partner either for one year or some other period or without time limitation until the loss has been completed absorbed. If the loss carryforward is without time limitation, it is usually called a high water mark. Additionally, sometimes general partners are subjected to a "hurdle rate" wherein their fee is conditioned upon the limited partners first getting a minimum specified rate which might be the yield on one year or five year treasuries. Usually the general partner gets a full 20% profit allocation as long as the limited partners receive the hurdle rate. In the event the hurdle rate is not earned, the general partner receives no incentive allocation. However, however, in reality, most funds without a past performing history (i.e. track record) do not have a hurdle rate, and as such, as long as the fund satisfies the aforementioned high water mark then the General Partner receives the incentive allocation. |
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