There are a number of compelling reasons money managers establish hedge funds, but it seems that wealth creation is a paramount goal among partners, and by a wide margin.
In a first-quarter survey by Flynn Family Office (FFO) of 188 general partners who have started hedge funds within the last five years and who manage an average of $63 million in assets, 92.6% said their goal in creating a hedge fund was personal wealth creation.
Along these lines, research in 2012 and 2013 found that nearly 84.2% of portfolio managers believe that being a hedge fund general partner was the most likely path to exceptional wealth.
There were, of course, other reasons. Managers are also drawn to the independence that a career as a hedge fund manager can provide, with 65.4% of hedge fund partners in the FFO survey citing “autonomy” as their chief goal in establishing a hedge fund. Only 14.4% said their aim was to become famous.
The survey illustrates the importance partners place on personal wealth. What many partners fail to realize, however, is that they need a foundation of advanced planning to achieve their goals.
Advanced Planning Opportunities
Without question, personal wealth creation is a measure of hedge fund success for general partners. Investment performance and a solid track record of returns are of course an essential component of asset accumulation efforts and vital to fund stability.
As they get their hedge funds off the ground, general partners tend to concentrate their energies and resources on three areas:
• Getting their hedge fund running effectively.
• Investing.
• Raising more capital.
If the stated objective is to achieve exceptional wealth, however, many general partners should add advanced planning to this list. Squarely focused on wealth creation through investment management, many new hedge fund partners do not initially address—or even consider—advanced planning elements that can substantially enhance or diminish personal and family wealth. Research suggests that most new managers are largely overlooking significant opportunities.
For the exceptionally wealthy, ensuring the continuity of family fortunes is often as important as the ongoing ability to amass assets. Many of the strategies used to protect and transfer personal wealth generally fall under “advanced planning,” which can be defined as the skillful leveraging of legal, regulatory and financial expertise to enhance and safeguard an individual’s or a family’s net worth.
Operationally speaking, advanced planning results in the repositioning and restructuring of assets to preserve and often increase the wealth of business owners such as hedge fund general partners.
Let’s now examine each of advanced planning’s three interconnected components:
Wealth enhancement is the process of using advanced planning strategies to mitigate taxes, resulting in greater personal wealth creation. By and large, general partners are often losing out by not focusing on wealth enhancement. For example, qualified retirement plans allow tax-deferred growth of assets through tax-deductible contributions, providing key strategies for hedge fund general partners. However, according to the FFO survey, only 21.8% of start-up hedge funds have a qualified retirement plan.
Aside from qualified retirement plans, there are many other financial and legal solutions that hedge fund general partners can consider to enhance wealth. It’s important that general partners are aware of their options in order to make informed decisions.
Estate planning is the process of legally structuring the future disposition of current and future assets. Eighty-four percent of the hedge fund general partners have a will or a more formal estate plan, according to the survey. And 89.2% of respondents indicated that their estate plans have not been updated since the inception of their hedge fund. As wealth increases and circumstances change, many general partners are missing opportunities to mitigate estate tax and wealth transfer costs.
When doing estate planning, hedge fund general partners should usually think in terms of how to drive the greatest benefits to their loved ones by leveraging the hedge fund. For example, the ability to “freeze the carry” is often overlooked as a possibility.
Asset protection planning is the process of employing risk management products and advanced planning strategies to reduce or eliminate the amount of personal and family wealth exposed to frivolous lawsuits and other risks. Asset protection planning allows ultra-wealthy families to limit liability to safeguard the family fortune. Nevertheless, only 12.2% of hedge fund general partners have a formal asset protection plan, according to the survey.
There are a plethora of bright-line asset-protection strategies that can be leveraged by hedge fund general partners. One of the most powerful and underutilized strategies is the captive insurance company. Though these structures can provide both superior coverage and tax planning benefits, less than 2% of hedge funds have established a captive insurance company.
Conclusion
Hedge fund general partners of start-up funds would significantly benefit by paying attention to how advanced planning strategies can enable them to create greater personal wealth. There is no question that their investment acumen is the underlying and primary driver of wealth creation. Nevertheless, by employing appropriate advanced planning strategies, the general partners can lower their taxes while ensuring their wealth is not depleted by frivolous and unfounded lawsuits.
Alan S. Kufeld, CPA, MST, is a partner at Flynn Family Office. He specializes in wealth preservation and income and estate tax planning strategies for ultra-high-net-worth individuals and families. He can be reached at akufeld@flynnfamilyoffice.com.
Frank W. Seneco is an advanced planning life insurance specialist. He is the president of Seneco & Assocates Inc., boutique planning firm in Connecticut. He can be reached at fseneco@seneco.com.
