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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. Tom is also a recognised expert
in the field of governmental tax reform
and has appeared widely on radio and television.
- 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.
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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.
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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.
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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.
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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 ().
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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.
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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 ()
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.
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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.
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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.
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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.
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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.
Contact Details
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.
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