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Forex hedge fund management

15.01.2007 12:59 Monday

I t's understandable why hedge funds have become so popular in recent years - from a trader's perspective. A talented hedge-fund manager can accrue substantial income, and while starting a hedge-fund obviously isn't for the novice forex trader, it's not as complicated as it seems. Let's assume a trader has a modest $3 million under management and his forex hedge fund has a I-percent management fee and a 20-percent performance allocation fee (Le., a share of the profits). Assume the fund was started on the first day of the year and returned 15 percent. In this case, the trader would have gross income of $120,000,consisting of a $30,000managementfee($3million* 1% = $30,000)and a $90,000performance allocation ($3 million * 15% return = $450,000 * 20% = $90,000). Using all the same assumptions, a hedge-fund manager with $10 million under management would make $400,000. Also, because prospective investors like to see fund managers' risk their personal capital, assume the fund manager has a significant portion of his own money invested in the fund. Because there are no fees assessed (it would just increase taxes), the trader earns an additional 30 percent on his own investment in the fund. However, before a trader can potentially enjoy these rewards, he or she must structure a proper business. The good news is forex traders are now positioned to quickly launch a forex 52 fund with minimal regulatory oversight. Forex fund basics Regulation D, Rule 506, of the Securities Act of 1933 defines a forex fund as an unregistered security offered as a private placement. Regulation D provides "safe harbor" provisions which, if complied with, exempt the private offering from compliance with the registration and prospectus delivery requirements of federal securities laws. However, Regulation D does not exempt the offering from compliance with the fraud provisions of the federal and various state securities laws.

Most foreign currency trading is eligible for favorable federal income tax treatment.

Forex funds must supply all investors with comprehensive information about the offering in "disclosure documents." The purpose of these documents is to limit the hedge fund's potential risk by providing full disclosure to investors. A typical set of disclosure documents includes a private placement memorandum, an investor questionnaire and subscription agreement, and an operating agreement for the fund. Most foreign currency trading is eligible for favorable federal income tax treatment. Regulated futures contracts, regulated commodity option contracts, forward contracts, and over-the-counter options in currencies for which there is also trading in regulatedfutures, all qualify as "Section 1256 contracts." Gains in these instruments are taxed at a maximum federal rate of 23 percent (60 percent of the gains and losses are long-term and 40 percent is shortterm). In addition, the fund usually qualifies as a "trader in commodities," so the investors are able to deduct the fund's expenses more favorably than expenses in an investment partnership. Performance-based compensation for fund advisers is usually structured as an allocation of profits, but it is sometimes structured as fees - in either event typically between 10 and 20 percent of trading profits. In some instances, the compensation agreement specifies that funds be only paid when the profits of the fund exceed a minimum rate, or "hurdle rate."

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