Rentech returns due to tax arbitrage?

Rentech is a quant shop that has been surrounded by mystery. The fund which I assume everyone has heard of has been racking up returns for years. From wiki: “For the 11 years ending in December 1999, Medallion’s cumulative returns were 2,478.6 percent.” Of course this pertains to Medallion results only. Bloomberg had an interesting article pertaining to their use of basket options to classify trading returns as Long Term capital gains as opposed to Short Term gains. The difference in tax rate is substantial, about 19.6% difference, 39.6% ST and 20% LT. From what I understand after reading the IRS memo, Rentech would purchase an option on a basket of underlying with 1-2 years expiration. It seems it was leveraged about 10x, not unusual for an option and had a knock-out provision given a 10% loss in the value of a basket. All this seems fairly normal. The interesting part is that the option issuer, in this case the bank, could change the content of the basket based on direction by Rentech. That is pretty interesting, it’s not often you can own SPY calls and then suddenly it’s IMOS. In this way, RenTech could buy and sell continuously, but because it’s all under the umbrella of the basket option, which expires after the 1 year holding period, it could be considered Long Term gains and taxed at a lower level. Very interesting Mr Simmons!


This current court case should be watched closely, I would imagine the powers to be to try to shut down these loopholes eventually but in the meantime I would assume other Hedge Funds would try to utilize this strategy. With the diminishing returns of typical strategies, tax arbitrage, regulatory arbitrage, lobbying etc seems like a new frontier of investing!


~ by largecaptrader on July 2, 2013.

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