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Lemley Yarling Management Co
15624 Lemley Drive
Soldiers Grove, Wi 54655
Bud: 312-925-5248       Kathy: 630-323-8422

November 30, 2012

Model Portfolio Value As of 30 November 2012

$ 659,079


Comment on Model Portfolio activity

In the spirit of in for a dime, in for a dollar, we continued to commit funds to value stocks. We added DreamWorks and St Jude to some accounts and also bought a few shares of Old Second National bank in even fewer accounts. We repurchased Dell, Sony and GE at lower prices than we sold in September.

The media continues to be infatuated with their creation called the fiscal cliff. We believe a deal will be reached in time to avert any long term damage. As to whether the deal is reached before the witching hour we are agnostic.
*****

November 23, 2012

Model Portfolio Value As of 23 November 2012

$ 646,974


Comment on Model Portfolio activity

We added to positions in some larger accounts to bring them up to 40% top 50% invested. We repurchased Facebook in some accounts and bought and sold Hewlett Packard. We bought it at $11 per share when it dropped 10% on Tuesday last upon announcement that the $10 billion Autonomy purchase of last year was a mistake (reading between the lines). OOPS. After sleeping on the purchase overnight we decided to eliminate the position with the reasoning that we avoided losing a ton of money by selling the shares at $24 earlier in the year and we shouldn’t be greedy. Moreover the mistaken $10 billion purchase suggests that management is less than stellar.
*****

November 16, 2012

Model Portfolio Value As of 16 November 2012

$ 629,827


Comment on Model Portfolio activity

We had to take a one day 30% gain in Abercrombie as shorts covered and popped the stock higher on good earnings news. We also sold our anchovy stock Facebook after it popped 10% when the lockup expired and the stock rose instead of falling. We have been adding JC Penney to accounts at a multiyear low. JCP is trying to reinvent itself and the bears are after it.

We also added Microsoft with a 3.4% yield after it dropped on negative executive news.

Investors Intelligence last reported 38% bulls- the lowest in five months and 28% bears- the highest in ten months. As contrarians that’s good news for our continued buying into year end.

The fiscal cliff remains a media obsession and handy media explanation for the market doldrums. Our take is that the markets have experienced doldrums action in November/early December for many years.
*****

Here is an interesting chart from http://digbysblog.blogspot.com/


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A Former Hedge Fund Manager Breaks Down How Wall Street Uses Its Favorite Tax Loop

When I set up my private limited investment partnership – also called, inaccurately, a hedge fund[3] – my attorney insisted I set up not one additional Limited Liability Company in Delaware, but rather two.  I tried to resist him, saying I felt most comfortable with just one new business entity.[4]  I was so averse to two new entities that I asked another attorney for a second opinion.  He told me the same thing.  I needed two entities.  I asked my accountant.  His response was, of course, “two entities,” and complete puzzlement at my resistance.  Clearly, they knew something that I didn’t.  That something is the awesomeness of the carried interest loophole.  Needless to say, I got the extra LLC.[5]

Why did my attorney and accountant insist I create a separate entity?  Because that separate entity can collect payments in the form of ‘incentive allocation,’ also known as ‘carried interest,’ which is taxed advantageously, at the same rate as long-term capital gains[6] rather than as ordinary income.  Here’s how it works.

If you set up a traditional hedge fund[7], first things first: you’ll want to charge the traditional “2/20.”[8] Embedded in this short-hand lingo of “2/20” for hedge fund fees are two types of income.

With the two types of income, you need the two entities to keep the income tracked separately.  Entity #1 collects the “2,” which is taxed like regular business income, and Entity #2 collects the “20,” which collects your totally awesome income at a lower tax rate.

The “2” refers to an annual management fee of 2% of assets under management.  On a small/medium-sized hedge fund of, for example, $500 million under management, you will collect $10 million in management fees per year.  The purpose of this money is to pay for rent, staff, overhead, technology, research – in short all the things you need to do as a fiduciary for the proper care and feeding of the client’s money.  This management fee income will net out with business expenses, and may or may not ever generate “profit” for the manager.  In some fundamental sense, it’s not supposed to generate profit; hedge fund managers are fine earning zero profits from management fees since the $10 million is taxed like ordinary income at 35%, which is, as you know, kinda lame.

The “20” refers to the incentive allocation, meaning specifically that 20% of all annual gains are retained by the manager, in entity #2, as ‘carried interest.’  Here, the hedge fund manager takes full advantage of the loophole.  If the $500 million fund has a gain on investments of 10% this year, fully 20% of the $50 million gain on investments – that is to say $10 million – gets earned by the hedge fund manager’s entity #2 as the ‘incentive allocation’ or ‘carried interest.’

At this point, that ‘carried interest’ gets treated at the rate of capital gains, a 15% tax rate, rather than the 35% taxable rate of ordinary income.  Often, by design, the hedge fund manager leaves the entire 20% incentive allocation inside the fund for it to grow long term.  The manager only owes $1.5 million in taxes (15% of $10 million, at the capital gains tax rate) instead of $3.5 million (35% of $10 million, at the ordinary income tax rate).  As a result of the special tax treatment for ‘carried interest,’ the small/medium hedge fund manager in our example keeps $2 million more than he otherwise would have been entitled to keepThat’s a good deal, for him.

And that’s just one year.

And that’s just for kind of a small hedge fund.

You can imagine the bigger, scale-able results available for when a John Paulson-type fund manager scores  big by shorting the subprime mortgages market in 2007 (probably saved about $740 million in taxes with the loophole) or buying gold in 2010 (probably saved about $980 million in taxes with the loophole)[9]

You can also see why my attorneys and accountant insisted that I set up a separate entity that could take advantage of the tax loophole for carried interest.  My keep-my-life-simple approach made absolutely no sense in the face of potential millions in tax savings year after year.  And they knew that.

Is carried interest deserving of special treatment?

Is there anything special about ‘carried interest’ that justifies the preferred tax treatment?

Proponents argue that because much of ‘carried interest’ stays invested inside of hedge funds, still at a risk of loss, that additional risk justifies the 15% preferred tax rate.

But typically much of that ‘carried interest’ left in the market could be liquidated and taken out by the hedge fund manager anytime.[10]  (You know what else is risky?  Having a job, with a salary, that you could be fired from next week, but you have to pay a much higher tax rate on that salary.  That’s pretty risky too.)

Other proponents of ‘carried interest’ argue that tax policy should incentivize the accumulation of our economy’s scarce investment capital, basically the Ed Conard argument for lower taxes on wealth and investments.

In my opinion, that’s bunk.  Capital is not that scarce for any truly innovative segment of the economy.  Most hedge funds and private equity investments offer little value-added as innovative engines of the economy.  I know that’s my hypothesis, not a provable assertion, but I’ve seen enough on the inside to know – these hedge funds are not the engines of innovation you’re looking for.

At the end of the day, the ‘carried interest’ money is treated better than salary money because it’s been earned by a special class of people – hedge fund and private equity fund managers – who are much more influential in the political process than the average worker.  Full stop.

All of this is why I wrote last week that I would appreciate it if both sides of the political aisle would just stop lying to us about fiscal policy and loopholes and treat us like adults.  I’m ready to be pleasantly surprised.  But I’m not going to turn blue holding my breath.

Read more: http://www.bankers-anonymous.com/blog/shhhhhh-please-dont-talk-about-my-tax-loophole/#ixzz2COfsvqid

*****

November 9, 2012

Model Portfolio Value As of 9 November 2012

$ 629,083


Comment on Model Portfolio activity

We repurchased Alcoa, Deutsche Telekom, Ford, JCPenney and Facebook in the Model and added to Walgreen, CSX, DuPont and Abercrombie to bring equity exposure up to 50% in some larger accounts and more in smaller ones.

The election removes uncertainty and while the knee jerk reaction has been a lower market the overall outlook is positive and so we are repurchasing issues sold at lower prices and also adding a few new positions. The Fiscal Cliff is a media creation. We watch Netflix rather than the news and feel much better.
*****

November 2, 2012

Model Portfolio Value As of 2 November 2012

$ 638,954


 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 



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15624 Lemley Drive, Soldiers Grove, Wi 54655 312-925-5248
The factual statements herein have been taken from sources we believe to be reliable but such statements are made without any representation as to accuracy or completeness or otherwise. From time to time the Lemley Letter, or one or more of its officers or employees, may buy and sell as agent the securities referred to herein or options relating thereto, and may have a long or short position in such securities or options. This report should not be construed as a solicitation or offer of the purchase or sale of securities. Prices shown are approximate. Past performance is no indication of future performance.