auditing your returns

P

praetorian2

I am curious if anyone here knows where I can get my returns for the past 3 years audited by a top tier firm. I also am curious how much you think it would cost to get them audited and certified by a top tier firm. It will certainly be hard as i've traded in a half dozen plus accounts at datek, terranova, cybertrader, and now IB. and have had multiple accounts at cybertrader.
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The second question that I have is how taxes are taken into account by auditors. If I have to make a large payment on april 15, and that takes my account down by 40%, then do I show a loss for it? Do I use my % return on the jan 1 date, or do i substitute my account value on april 15 for the jan 1 date b/c the account will be 40% lower in value.
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The 40% refers to an account that is growing at over 100% a year so estimated will not keep up adequately.
Thanx in advance. I think that this step is necessary as I start to market my hedge fund.
 
No one replied so far, maybe they didn't understand the questions. Say hypathetically on Jan 1 I have 100k in my account. I owe 40k in taxes at that point because the estimated taxes I paid the year before were to small. On April 15, I owe 40k +15k in estimated taxes (55k total), and my account is at 130k (a 30% increase).
Paying those taxes take my account down to 75k (130-55). At that point for the year, am I considered to be:

- Down 25% (100k starting -55k from last year)

- Down 10% (100k - last year's 40k only)

- Up 30% (30k in gains on the 100k in starting)

- Up 50% (30k in gains on 100k-40k in back taxes which is a starting point of 60k)

- Up 67% (30k in gains on 100k-55k in back taxes plus my next estimated which is a starting point of 45k)

Basically, I'm asking how taxes are treated in regards to total returns when auditing. I think that since I pay taxes that are larger than my account was on jan 1 of that year each year, it very dramatically affects my % return if i'm getting audited. For instance, this year, while I'm up a ton in $ profits, my account is still smaller than it was on april 14 just because of taxes I owed.
 
If you want to calculate your return for a period where you have cash flows into or out of your account you would...

-- calculate the return for each subperiod between cash flows, then
-- geometrically link the returns for the subperiods to get the overall period return

So for your example, you start January with $100k. You grow that account to $130k at April 15th. Then you withdraw $55k to pay taxes.

Since you didn't make any cash flows into our out of your account during the period (only at the end of the period), you can claim that your return (gross of taxes) was 30% for the year-to-date on April 15th.

Going forward from April 15th, you would use $75k as your starting capital to calculate your next period's return.

Whenever you read hedge fund results, they are (almost) always gross of taxes.
 
Oh, and while hedge funds report results gross of taxes, they also report results net of expenses. So, while you may have made 30% for January to April 15th gross of taxes and net of brokerage commissions, you should still subtract out whatever your management and performance incentive fees will be. If you are going to charge 2%/20%, then your 30% might drop to 23%ish on a pro forma basis net of fees.

Glossary:

<b>gross</b> - "ignoring" or "not taking into account"

<b>net</b> - "including" or "after subtracting out"

<b>pro forma</b> - "as if". You would report results "pro forma" net of fees. You didn't really have to pay the fees to anyone, but you are reporting your results <b>as if</b> you had to pay fees so your results show what your hedge fund would have returned <b>as if</b> it had been in existence at that time.
 
Thankyou. I appreciate your responses. So at a hedge fund, I only report net gain, and that is profits-commissions (my commissions last year were about 70% of my profits). Doesn't that leave any fund that had a good year at a serious disadvantage because they'll loose 1/3-1/2 of their account on april 15 and have significantly less capital to trade with for the rest of the year?
 
And about auditing your results...

I would say you could go to any CPA for your audit. You don't need to go to one of the Big Four (or Big Three, or however many are left).

Not being an accountant, I would think your CPA should be able to audit your returns just based on your monthly statements and your tax returns (to verify that you are including all your accounts). It shouldn't take more than a few hours of their $100-$200 per hour time.

You may not even need to have your returns audited to get started. As long as you correctly calculate your returns (ask a friendly bookkeeper friend or something) and label them as unaudited and predating the inception of the fund, you can show them.

Historical, principal-funds-only returns are better than hypothetical "backtested" returns, but they aren't as good as real time returns. Start your hedge fund ASAP, even if you only have one other investor. The <i>real</i> track record for the fund is your most credible history. For example, after the <a href="http://www.schindlertrading.com/schindler_fund.htm">Schindler Fund</a> had 6 months of actual history, we dropped all references to results prior to the inception of the fund.
 
Aaron, I really appreciate your responses. I was told that it is in my best interest to pay up for someone with "clout" it would make my returns look far more impressive to perspective investors. As per starting a fund, while I still want to get one up by jan1, if I can only find 1 other investor, I just don't see any use in paying for the setup, and the auditing and all other expenses. I don't think that I'll be able to ever get the type of exposure I would need to get additional capital. Do you know of a way to get some capital at all? or can you connect me to the people you used? Thanx in advance.
 
Aron - thanks for your postes verry interesting topic.

You say "performance incentive fees are net - including"... now lets say for example I have 2% managed fee and 20% performance fee calculated quartaly. So my equity chart drops every first day in the quarter down 20% on the performance I made and 0.5% on the equity.

I think big money is comming in with a good risk reward ratio.... so there is my problem now If I calculate as shown above my risk reward ration is 1:1 istead of 3:1 and my equity chart do not look that good annymore.

So how is the best way to calculate this fees in without having a big drop 4 times a year???? is there a way? thanks for anny ideas
 
You asked about hedge funds having a lot less capital to trade with after April 15th arrives... A few comments...

-- If you are making so much money for your investors that their April 15th taxes are so much that they need to make a substantial withdrawal, then you are going to have no trouble attracting more capital. Even if they are giving their investors big tax bills, profitable funds don't have asset gathering worries -- unprofitable ones do.

-- If you are so profitable that you are throwing off big tax liabilities, investors are going to try to pay their taxes out of income outside of your fund. They will want to leave their investment with you alone to further compound.

-- Funds that are so profitable that they throw off large tax liabilities are also growing a lot through reinvested profits. Taxes will only be a portion of the internal growth in the fund. That is, profitable funds will grow over time even if they don't find new investors.

-- And then, finally, the US government wants its taxes paid year round. April 15th might not be such a big factor if people are making small withdrawals of profits quarterly to pay estimated taxes.

In summary, giving your investors a big tax bill isn't a problem because it means you are very profitable. That's a blessing, not a curse. It's when you aren't giving your investors a big tax bill that the problems start.
 
Using my own example, I made over 200% last year, so when april 15 comes by, my estimated taxes were very insignificant. Since my only cash is in my fund, I had to pay out 50% of my own capital on april 15. 40% owed and 10% for esimated. This year I'm not having as great of numbers as of yet, I'm only up like 40% or so. Yet as a result of paying those taxes, and some personal expenses, my account is about 20% lower now than it was on jan1. This I believe WILL dramatically affect my returns this year in comparison to last year, will it not?
 
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