The industry of hedge funds has seen tremendous growth in the last five years. In 2010, Hedge Fund Research, Inc. reported that 1,000 new hedge funds have entered the market, and nearly the same numbers are launched every year after.
Emerging hedge funds often struggle with finding a balance between establishing a performance track record and building an efficient operational framework. Performance always comes first, but no matter how impressive returns are, inefficient operations cannot sustain growth and will turn away many potential investors.
Structure
Hedge fund managers must consider early on how to structure their company because this will determine which tax laws affect them. Choosing between a transparent partnership and a corporate structure will depend on investor needs, trading jurisdictions, and the physical location of hedge fund principals.
Ample time should be devoted to reviewing structural options. The needs of investors, as well as the fund’s strategy for growth should be weighed when deciding between appropriate legal structures.
Tax due diligence
In the early years of the hedge fund industry, showing performance records and creating a strong sales pitch may have been enough to persuade investors. Nowadays, investors are very are particular about the details of a fund’s operation and taxation systems.
Many institutional investors prepare due diligence questionnaires. Fund managers must be prepared to answer queries related to exposure management, tax allocation methods, tax estimates, and other tax related concerns.
Carried interest
Carried interest is the allocated profit received by a hedge fund’s general partner for managing the investment partnership. As the government is always looking for tax offsets and striving for regulation of hedge fund practices, the taxation of carried interest should always be a consideration for hedge fund managers.
Managing separate accounts
Some investors may be interested in a particular strategy but hesitant to invest in an emerging hedge fund. Managers assuage their fears by establishing a separate account where they have trading control but limited access to the investor’s assets. Fund managers must be aware of the tax implications of such practice before implementing it.
Data reporting
The government has been setting stricter reporting regulations for hedge funds. Investors have also started demanding reporting systems that will inform them about compliance, risk management, and consistency of investment strategy.
These tax considerations must be dealt with in the early stages of a hedge fund’s investment cycle if frameworks are to be set for maximum growth.
