Emory Partners is an option arbitrage hedge fund based in United States, whose average return over the last ten years has been 30% per year. Its Director, Thomas A. Wright is also a recognised expert in the field of governmental tax reform and has appeared widely on radio and television. In this 2005 hedge fund interview with Eurekahedge, Thomas A. Wright shares the strengths of Emory Partners, its portfolio diversification, the strategies they focus on and his opinions on the FairTax.
- What is the hidden strength of Dynamic Option Arbitrage and how does it complement your short-bias strategy?
While we add a short-bias balance to a portfolio, our greatest strength has been delivering well beyond the historical returns of most short-biased funds. Where they work very hard to tread water or limit losses in volatile bull markets, our historical returns have been in high single digits or even double digits. And when markets turn bearish, choppy and sideways, Emory has delivered high, double-digit returns, going as high as 60% (net to investors) in 2002.
We'd like our strength in this area to not be hidden at all! In short, our founder and chief portfolio strategist, Darrell Malick, discovered an anomaly in options pricing more than ten years ago. But an anomaly does not necessarily make a profit. Next, one must fashion a trade to take advantage of the anomaly. And that trade must make money. And that anomaly must be a permanent factor in the markets to profit for long. Fortunately, the anomaly is structural, and a profitable trade can be fashioned to take advantage of it. To make that trade most efficient - maximum profit - it has a short bias. Thus, the nature of the trade led Darrell into the short-bias world, which was not at all new to him as he spent many years with a short-only, equities-based hedge fund in a previous life. Simply put, the trade that takes best advantage of the anomaly Darrell discovered just happens to exhibit a short bias.
- What have been the key decision factors to select this strategy?
In short, it is the nature of the trade that brought us here, not a strategic decision on our part. However, from a marketing point of view, we're very happy with the result. Most short-biased funds, while working very hard to deliver the promise of their strategy, fail to deliver consistently or with sufficient profit to justify the risk. Not so with Emory Partners, which gives us an excellent opportunity to help in the construction of properly diversified portfolios.
- We are primarily interested in the fund management process and within that, we are interested in two things. First, we want to know where the alpha is coming from and second, is it sustainable.
The alpha comes from the arbitrage: taking advantage of pricing inefficiencies in options on futures, but with a balanced hedge. We've now been at it for more than ten years, and the pricing inefficiency continues unabated. Yes, we do know the source of the inefficiency, and why it sustains, but we don't reveal that broadly.
- Arbitrage funds are known for their low volatility but in the history of your fund, we saw a large drawdown in September 1997, what happened?
In short, Emory did not recognise that we had risk with our broker — and had all of our assets invested through that one broker, a relationship that predated Emory by years. The longer story includes Victor Niederhoffer's blow-up on Black Monday where he was reportedly shorting many put options (Emory held some similar instruments) when he went totally long on a US$100 million portfolio and lost US$150 million in a couple of days. Emory made money throughout Black Monday. Despite the roiling of the options market, Emory's strategy weathered the storm fine, had sufficient reserves to handle any usual, nominal margin call (which did not come), and would have returned to profitability promptly. However, Emory's ex-broker's law firm called a couple hours before the close on October 31 and took the margin requirements up 700%, well beyond nominal.
What did Emory learn? That we had an unidentified risk with brokers. That our strategy's risk control systems work, even under unusual market conditions. To diversify assets with several brokers. To vet brokers carefully before bringing them on board. And to test their mettle as soon as we put them on board. If their risk/credit department balks, we find another broker. With the above steps, we believe we have protected our investors against a repeat. And we returned to our high-water mark in 24 months.
- What are the investment experiences of the portfolio managers?
Due to the nature of our registration, different from many hedge funds, all of our trading and marketing personnel must be Series 3 licensed. But Darrell is the key strategist, so here is his background.
Darrell has been in the hedge fund business since 1989. He currently serves as Managing Partner and Chief Investment Strategist for Emory Partners, a strategy he founded in 1993. Prior to managing Emory Partners, he rose from Accounting Manager to Chief Operating Officer for and Partner in Feshbach Bros, a firm best known for pioneering the area of dedicated short-selling in the equity markets.
His education and work experience prior to that was in the field of electrical engineering, and this engineering and mathematical background has had a great influence on his trading style. After several years at Feshbach, Darrell began researching the stock indexes and commodities markets. He wrote a series of computer programmes with the aim of predicting various markets. These computer programmes explored state-of-the-art pattern recognition, market sentiment, and a wide spectrum of technical analysis tools. Although some of these programmes were modestly successful, Darrell ultimately concluded that no really reliable edge could be developed in predicting the future price movements of the markets. But this research yielded a by-product: a completely different approach to trading than is applied by other investment fund managers.
This by-product started with a study of options as a means to control the various risks of futures trading. This ultimately led to the discovery of the inefficiencies in the options markets and led to the development of the Dynamic Option Arbitrage strategy.
Darrell attended San Jose State University (electrical engineering) and has completed considerable independent study in electrical engineering, accounting, computer programming and investing. At one time or another he has held the following licenses: Series 3, Series 4, Series 7, Series 27, and Series 69.
In his philanthropic pursuits, Darrell is most involved in social betterment, helping children, community activities, Boy Scouts and the grassroots movement to replace the income tax system with a national retail sales tax (www.fairtax.org).
- Now, I know you are also the Executive Director of FairTax.org based in Houston, Texas, which proposes a revenue-neutral national sales tax to replace both the income and Social Security tax systems and no IRS. So tell us about FairTax and how it can overcome disadvantages of the current tax system.
The FairTax proposal is a comprehensive plan to replace federal income and payroll taxes, including personal, gift, estate, capital gains, alternative minimum, Social Security/Medicare, self-employment and corporate taxes. The FairTax proposal integrates such features as a progressive national retail sales tax, dollar-for-dollar revenue replacement and a rebate to ensure that no American pays such federal taxes up to the poverty level. Included in the FairTax plan is the repeal of the 16th Amendment to the Constitution. The FairTax allows Americans to keep 100% of their paychecks (minus any state income taxes), ends corporate taxes and compliance costs hidden in the retail cost of goods and services and fully funds the federal government while fulfilling the promise of Social Security and Medicare.
For my friends in the hedge fund world, imagine combining the tax-friendly structure of island tax havens, with a job-producing corporate tax structure going well beyond the Irish model, and overlay that in the world's largest, wealthiest market with its enviable business infrastructure. Does the word juggernaut come to mind? In short, any income tax anywhere is just sand in the gearbox of that economy. Our economists predict between 7 and 14% GDP growth in the American economy in the first year without an income tax.
- What are the latest developments at FairTax and is there any official statement coming from the White House?
Our organisation did much work with President Bush long before he was president. When he was governor of Texas, his party's platform document made these recommendations regarding the replacement of the federal tax systems, and it still reads this way today:
Federal Tax Reform — Federal tax reform is required and any reform should support free enterprise, economic growth, be simple and fair and support job retention in the United States. The Internal Revenue Service is unacceptable to the US taxpayers! The Party urges that the IRS be abolished and the 16th Amendment to the US Constitution be repealed. We further urge that the personal income tax, inheritance (death) tax, gift tax, capital gains, corporate income tax and payroll taxes be eliminated. We recommend the implementation of a national retail sales tax, with the provision that a two-thirds majority of the US House and US Senate is required to raise the rate. Such reforms will encourage investment and economic growth. Lastly, such a sales tax plan must ensure no one in America pays taxes of any kind on the necessities of life, ensuring opportunity and quality of life for low and fixed income Americans. We believe every tax at every level should be a separate and clearly visible billing to the taxpayer, regardless of type of tax, and of the calculation method, so we support tax visibility in all forms. (Source: www.texasgop.org)
For a video of the President expressing his thoughts on the FairTax, specifically, go to our website (www.fairtax.org) and select the video clip of the President Bush. We have much support in the House of Representatives; we have work to do in the Senate.
- We are interested how FairTax can morph into a win-win situation as far as pro-growth policies are concerned. I mean President Bush already gave a substantial tax relief and appointed a Tax Reform Advisory Panel to help develop options for fundamental tax reform. Why the FairTax and not flat tax or staggered income taxes?
Staggered (progressive) income taxes are suggested by Karl Marx Communist Manifesto. Surely, with only a couple of communist nations left in the world, the financial markets can see the graphic failure of such destructive ideas. It is interesting that the Unites States has a Marx legacy for its tax system, while Russia and much of Eastern Europe now have flat taxes. But since no form of income tax has a structural impediment to lobbying, Russia's Steppes Tax will become their Urals Tax soon enough. Lobbing for special interests is not the exclusive purview of American politics. And the last indictment for any income tax is that conclusively stated by our Founding Fathers. Any income tax — allowing the central government to reach out into homes, businesses and churches — will be wielded as tool of tyranny, punishing enemies and rewarding friends, sundering civil liberties. This is why our founders specifically outlawed such taxes in the unamended Constitution. With the passage of the 16th Amendment, such taxes led to the development of the largest domestic surveillance agency in the history of the world: The IRS is bigger than the KGB, Stasi and SS. Sales taxes, on the other hand, are transparent, easily understood, collected under the bright lights of the retail counter, where changes are obvious to all. Lobbing is difficult (but not impossible). Our Founding Fathers knew this from their study of tax systems throughout history, and this is why they limited the federal government to only taxes such as the FairTax.
- Who/What do you think is the biggest traction to this issue?
The "don't touch my paycheck" lobby is our strongest proponent. Common, everyday, working men and women who are sick and tired of their paychecks arriving with a big hole in them. Keeping voluminous records. Having to hire people to prepare their returns. Having to report their smallest transactions to the federal government. Grassroots America is fed up and the revolution is well underway. Even if they do not understand how income taxes and their complexity is driving their jobs offshore, they intuitively know such taxes are just wrong and need to be terminated.
- Putting hedge funds and FairTax in the same context, how can passing the FairTax bill be advantageous to the former (or its investors) and the state of US economy as a whole?
We're back to the tax haven dream. I don't even have an accurate estimate of the trillions in capital trapped offshore due to our insane corporate income tax laws. When the entire US is a tax haven, that capital will flood our markets, looking for new homes. This will lead to a boom in financial services well beyond our wildest dreams. Daimler Chrysler would be Chrysler Daimler, and based in Detroit. And so on around the world. Manufacturing comes here. Our economy becomes turbocharged. And in the interest of full disclosure, Emory's short bias will limit this event's positive effect on us. But such a rising tide will be volatile, and we do quite well in volatile, bull markets. Just not as well as we do on volatile bear markets.
- Lastly, tell us the joy and difficulties of being in a hedge fund management company and in a grass root organisation.
To balance such different careers, simultaneously, requires a very tolerant employer, wife and children. The Malicks and I are true believers in the FairTax. They often travel with me to various events, and we do occasionally find an investor along the way. But what the FairTax will do for our children and the nation is appropriate compensation. For that matter what the FairTax will do for the world is good compensation. As I study the American tax system and look at the rest of the world, I find that our bad ideas have spread like a cancer. The only error the US does not export is a value-added tax, but the French, economic whizzes that they are, have done a masterful job of crippling much of the world with this travesty.
When the US cures itself and becomes more competitive internationally, other nations will see that success and emulate it. Thus, the FairTax concept will travel well beyond the confines of North America (displacing the French VAT worldwide), and in short, initiate not just an era of prosperity, but also one of enhanced civil liberties. Frankly, I would be happy to come out even on prosperity, if freedom is the dividend. Getting both is gift of inestimable value.
Thomas A. Wright
Emory Partners LP
+ 1 727 712 3774
Eurekahedge does not warrant the accuracy of the information within and does not purport to be providing legal or tax advice.