The Hot New Thing in Tax Avoidance

Podcast on Apple Podcasts, SoundCloud, and Bloomberg dot com. Right now, we know that investors are hoping for returns that are often bigger than what a lot of institutional managers will say that they can get, and they don't want extra taxes cutting into that. And there's a new popular way to avoid taxes that has um name that's less than exciting,

insurance dedicated funds. Here to tell us a little bit more about these and why they're a little bit more exciting than they sound, Tom Metcalf, who is able to produce reporter in choices in our Brick eleven three our studios, Tom, what exactly our insurance dedicated funds? So they're pretty complicated product. Basically, they're a way for very wealthy investors to invest in hedge funds and without have to pay any sort of tax on those gains. So there's two types a life

insurance product and an annuity product. But basically what you do as an investor, you effectly buy a life insurance product and then that insurer will invest for you into a hedge fund and then there is absolutely zero tax on that. Do you have a sense of how big the idea for the insurance dedicated fund industry has become? So it's pretty hard to get like official statistics. One guy said, you know, people are trying to keep this relatively quiet just because it's so successful. They don't want

everyone else to know how well it's going. But one one guy sort of estimated for us it was at least fifteen and perhaps eighteen billion in terms of total assets, and that's tripled over the last ten years or so. Let me just get a handle on this, because it's not necessarily new that insurance policies are used for things

like a state planning purposes. Right, if you have a projected tax bill because of your estate, many times what you'll do is you, if you can afford it, you will pay the premium for an insurance policy whose payoff value to the beneficiaries is equal to whatever the tax liability is. So in other words, you're getting a tax free distribution from your insurance policy and you use that

money to go and pay your estate taxes. That's already well known and I mean, I mean it's pretty widely widespread, correct, Yeah, And this is sort of, I guess, even more grander than that. So it's become a more popular because what we're seeing is obviously family officers that have exploded, So you're getting so many more investors out there you can afford to leave their money locked away effectively for decades.

And also the difference here is effectively you can with this structure effectively avoid any sort of tax on that death benefit if it's structured correctly. Well, So, just to give us a sense of how this differs from a typical annuity, just in terms of the promised yields. What kind of returns on their investments have some of these

wealthy individuals been expecting to receive. So in some of the marketing documents it's basically, over say a forty year period, you can under a normal structure, get about fifty million in terms of a total you investment two I think it's two and a half million over four years, and then leave it there, you know, making returns for forty odd years, and that would be fifty million under a normal structure, and in this sort of totally tax restructure

that rises to about hundred and twenty million. Holy cow. Well that's because of the tax, the tax status something of the investment, right, because it's growing status. This is because they're investing in huge funds. They're not investing in just sort of income producing securities. Right. Um, it's both basically,

So it's effectively in terms of that hundred twenty million. Basically, if you are the beneficiary rather than ensured, that hundred twenty million will landing your bank account for all effect without any tax at all. Right, because it's an insurance payout. Yeah, because it's a life insurance payout, right, and when meeting life insurance meaning you're not going to get it, the beneficiary is going to get I said, well, I could buy the policy for and insure someone else, so I

could be the beneficiary. So you know, let's say I have a nice elderly relative. Perhaps that might be a thing I could do if I had to spare. You know, people say about you need seven to eight million. But that also used to be a very popular investment product. Which is banks companies. I mean they were viadical settlements. In other words, you would ensure someone else and when they passed away that the benefit of that policy would

accrue to you because you paid the premiers for that person. Yeah, exactly. And the guess the twist here is the involvement hedge runs that you get to select because technically you don't get to select what the insurance company invests in. But now you're saying that you can do this by selecting these specific kinds of products, these idefs. Yeah, you've got to be very careful. So the I r S looks very closely at this in terms of you can't show

what they term investor control. But basically, and this is another reason why it's becoming more popular, is what you can do is move from fund to fund. So let's say you're invested in one hedge fund and you go, I can't tell them what to invest in, but I don't like their performance. You can move to another. They are called insurance dedicated funds without any sort of kind of implications and tax works or anything. This is such

an interesting story. And one thing that you talk about is that these vehicles have become so mainstream that you've got banks like JPMorgan and Goldman Sachs offering them, as well as hedge funds like Paulson and Company and Millennium Partners. And it was interesting and somewhat telling that no one wanted to comment for your story whatsoever. And you know, do you do you think that, um that there is some concern that regulators could kind of home in and

try to remove the loophole that's kind of being exploded here. Yeah, we were asking the various people spect to the story about that. And what has happened originally is the RS is constantly raised, a few lawsuits and stuff. I think at the moment there's a feeling which is again, popularities increase and as long as you're very clear and can make this case for invest in control that you're not involved,

that they're quite secure. And I think part of the reason they're not commenting as well is you know that it's a private placement, so they don't they're not really allowed to talk about sort of client issues like that. That's what they told their compliance department would probably you know, a brain uh melt down just just quickly. Insurance payouts are in a sense guaranteed. Right, you buy a life insurance policy for a million dollars, it pays out a

million dollars. In this case, you buy a life insurance policied invested in hedge funds? Is there any guarantee? Um? I mean it's variable. And in fact it was a case where a guy who invest in these is a rich head from guy and invested as in a I d F and then try to sue them because they didn't get the returns he wanted. So there is definitely that risk level. But when you take out tax, as long as you're not going for a super super high

risk fund, then it's just easy returns. On that level at least, it's almost like having an additional IRA A right, I mean the money grows tax free. Although the IRA case you actually attacks when you pull the money out, in this case you could potentially not pay anything. Thanks very much, Tom Metcalf, always a pleasure talking about i dfs. We're talking about insurance dedicated funds. Check it out Bloomberg

dot com. Well, companies all across the world are still grappling with a cyber attack that's similar to the want to cry attack that we saw a couple of months ago. Um, it's reached parts of Asia after hitting Europe, US, South America, and who is really to blame? I want to bring in Robert Knapp's chief executive officer and co founder of cyber Ghost, which is based in Bucharest, Romania. Robert, thank

you so much for joining us. In previous news articles, you've been quoted saying that, frankly, governments are in large part to blame for some of these cyber attacks because there you know, for example, the U. S N s A, We'll find some of these loopholes and problems with programs widely is programs, and they won't report them because they want to be able to access people's information. Can you

talk a little bit about that exactly. I mean I was talking a couple of years now about the fact that we have to decide in the future how we wanna move forward with online security. One of the big problems we see now and these attack shows it, um

and leave me. We are just now before the next attack because all these attacks we see, how we saw in the last years, are using so called backdoors means um loopholes in in normally secure systems that are either implemented by um national security organizations or detect a financial security agencies and not reported to the developers, because these agencies use them to spire on people, which weakens the

security for all of us. And I think we need to make a decision um as a as a society about how we want to proceed in future with putting our whole life on the internet. Robert, would this would would an analogy be that, you know, in in some science fiction movies, you know, you've got the scientist who's trying, you know, creating some crazy chemical, you know, to rule the world. But it gets loose, right, it gets loose and someone else takes it and does bad things with it.

Is this what's happening right now? I know, not exactly. I I know a better analogy. It's like, you know, it is like we live in a neighborhood and we implement now in our houses absolutely safe doors so nobody could break into the house. But the police has the idea, let it make even more safe. Leave all of us, give us a key, so so we could prevent the bad guys entering the door. Okay, but here's what I

don't understand, Robert. But here's here's what I don't understand, because if the government is to blame for not reporting some of these back doors and loopholes, wouldn't the technology companies hire some people If these hacks aren't that difficult to do, wouldn't they just hire a team of people to try to break in and go through every back

door and find every vulnerability and fix it. Um. I disagree that the point is that would that would mean that we believe that it's possible to build one hundre the centature systems, so and that is simply not possible. Um. We're speaking here about highly complex systems with sometimes hundreds of thousands and millions of lines of codes. So the problem is, first of all, we cannot build safe systems

once we detect the vulnerability. We need to have laws that prevents anyone from using these vulnerabilities and to report these vulnerability So that means we need a common effort into into making the web more secure and not making the web more unsecure. And you know, having state organizations having these keys are not giving them back to the

rightful owners of the doors. That doesn't make sense and the reality shows that, UM, this is not the way to go for the future because we're gonna see now more and more of these kind of attacks that all used vulnerabilities in normally secure systems. Well, given the current political environment, it seems unlikely that there's going to be a consensus about very much, specifically about cyber attack accent

trying to put forth some kind of legislation. I'm wondering if you could offer businesses and individuals any advice on how to prepare or deal with the current cyber attack and future attacks. What should people and businesses be doing. Look, the weapon of the twenty one century is encryption technology. So the answer exists. The solution exists. We have it.

It's pure mathematics, and it's called encryption. So that means protect yourself with tools like our cyberablest hand that is an entrypted come into the internet, use PGP for your email, use encrypted check systems, and do a pack up of your data. So the problem that we see right now we want to try to take over these kind of

a kick is that these people lock your data. That means the only way to protect yourself from that is to back up, but to pick ups keys in a way that you would encrypt your data in the cloud. So don't pick ups in the clouds a pickups in your own networkeding on and try and trypt your data. And as long as we don't have bactors and encrypted solutions, these solutions are really safe. I want to thank you very much for joining us. Robert Napp is the chief

executive and the co founder of cybergost joining us from Bucharest, Romania. Well, he is here to continue the saga of Puerto Rico. Joe Masac is our editor for Bloomberg Briefs Municipal Market Brief and he joins us in studio. Joe, you know, I'm I guess this is what chapter. I don't even know what chapter this is in the long saga and story of Puerto Rico. But the Puerto Rico Board has some checked in the power utilities debt restructuring. Bring us

up to date on what's going on. Oh man, the board last night and executive meeting said that the Prepper deal, which promised to give creditors but cents on the dollar and was the only deal that they came to pre bankruptcy only deal right, Uh, that that no longer was alive and that they should go back and uh it

looks like, now it's going to happen. If Prepper is gonna wind up into some you know that they're gonna wind up in Title three bankruptcy along with the you know, the Commonwealth, the GEO holders and Cofino holders are slugging it out. So now you're gonna have Preppa in the

same boat. And uh, the board not only did that, the Board also threwout the budget last night that was passed by the legislature and said, no, you know what, you have to take another three million dollars out of this budget and the budgets about nine and six billion. So they were very busy last night. The board is

asserting their power. Yeah. Well they also Puerto Rico also said that their fiduciary duty was not too bondholders, it was to residents of the island, which is a stark departure from typical bankruptcies where the company's fiduciary duty really is two creditors first and foremost. Right, Well, you know

the Yeah, they're arguing that today in court. And uh, you know, actually, the the adversarial relationship there, we saw glimpses of it in nine the Orange County bankruptcy, and then it really came back in Detroit, where the city said, well, guess what, GEO bond holders are going to have to take a haircut, and they did. Uh So, the the adversarial nature is something that we have seen in the muni market, the business about well, we don't really of a fiduciary duty and guess what, we have to take

care of the people on the island first. Okay, So if that's the case, why why is anyone surprised? Why is anyone anyone surprised that the Fiduciary Board is throwing out these agreements, reducing the amount of money in the budget, basically doing everything that it can to protect the island

and its people rather than creditors. Well, no, actually the board went throughout the budget is really saying, you know, on the one hand, yes, on the PREPA deal, they're saying, it looks like bond holders are gonna have to take more of a haircut than fifteen cents on the dollar. But with throwing out the entire budget, they're saying, you haven't made enough cuts. There are going to have to either be employee furloughs or we might have to cut

back those Christmas bonuses to government employees on the island. Uh. So the board is being how should I put it there, being very hard right now, and they should be no cash. I mean there was a story in the Wall Street Journal this week about how Puerto Rico is looking to sell itself off in pieces to raise money. Oh sure, yeah, and I suspect that the board is going to have a very um uh you know, they'll have something to say about that now. Whether they, you know, approve those

sorts of sales or not, we'll see. But I would say it's almost good, you know, from a I don't know from a public finance point of view, that somebody on the island is is sitting down and taking things very very seriously as opposed to what's sort of gone on before here. Well, let's can you just put this

into some kind of perspective. I think you mentioned what the total budget that was passed was nine point nine point six nine point six billion, just to give that comparison, you know, the budget of the City of New York is eight five billion. Uh. State of Rhode Island I think about nine point two billion. Why is I mean these are they are large sums, but the havoc that they are going to wreck on the economy is gonna last a much longer time than just a one year budget.

Is there a cohesive plan or is anybody thinking about what life in Puerto Rico is going to be like for businesses and people after this happens? Or presumably the the Federal Oversight Board is and they they seem to have taken or are taking the long term. Look. You mentioned that the haddock that this is going to a reek. Uh, you know, recall back to the nineteen seventy five in New York City, which did not go into Chapter nine bankruptcy,

but entered a period of austerity that took perhaps ten years. Uh. In many ways, a lot of the the infrastructure problems we're seeing in New York City today or you know, could almost be traced back to nineteen and that extended period of austerity. So who knows how long it's going to take for Puerto Rico to you know, turn the corner.

You know, Joe, I have to wonder as we talk and focus on Puerto Rico's differ cultis I have to wonder what precedent it sets for Illinois, which is teetering close to junk status with respect to its credit rating and is facing a whole host of problems. I mean, is there anything that debt holders are taking. Are they selling more aggressively because they know that they could get um,

they could get shafted in a future reorganization. Actually, uh, you know, the banks I've read several analytical comments in the last couple of weeks saying, hey, you know what, Illinois actually represents a value right now because it's trading so far out of line, almost three basis points over the triple A scale. So Illinois gus. They're talking New

Jersey appropriation back debt. Uh. The banks are saying that, you know, these are recommended because the U States, unlike Puerto Rico, uh you know, A, they don't have bank criptsy right now, but be the States are still very strong and have a lot of flexibility. So it's sound you know it always it always sounds apocalyptic and now all right risk on stale for at least across the Wall Street analytic desks. Joe Mysak, thank you so much for joining us. Joe Mysak is the editor of the

Bloomberg Brief that's focused on the municipal market. Talking all things this moment of the muni, stock buybacks and free cash flow. How do you use them as a strategy in order to make money? Well. Charles Biederman is the chairman of trim Tab's asset management and he joins us now to tell us more. Charles, always a pleasure, Thanks for being here in our studio. Maybe you could just give a little bit of a description as to how you came to formula this strategy and the experience that

you have in implementing it. Well, all there is in stock market of shares of stock and money, and so if companies are growing cash and using a portion of it to reduce the share count, the price of the remaining shares should go up by the percentage of the share count reduction, everything else being equal, particularly since they

generate using cash that they're generating. Now there's a difference if they use cash that they're borrowing, because that increase increases risk and it means they don't have the cash to do it. So you want to buy shares in stock first. Companies are growing cash, and if they're using a portion to reduce the share a count and they're not borrowing to buy that's our strategy for trim tabs. Uh Flow drink et F which we launched in October,

and as you know, we've done quite well since. I've been on the show many times with you in the past us talking about it, Charles, I'm wondering there are so many people who are launching exchange treated funds right now. Does it matter whether you have a good idea or is there something else that works with respect to marketing and e TF Well, I think performance works, always hasn't always will. In essence, we're a hedge fund at a fifty nine speak basis point price. In other words, we

have a formula and no one else does. Now. We just launched today trim tabs International Free cash Flow uh t t A I is the ticker symbol. It's gonna do exactly what t t FS does in the US to non U S stocks. It's going to be about eighty five stocks UM Developed countries, Asia, Canada, UM, Europe, etcetera. And uh it's companies growing free cash flow, reducing the share count and maintaining a strong balance sheet. So it's a global compliment. So the U S one is work.

We've outperformed in the past of the Numbers Show, Morning Star. Whatever we've outperformed by several hundred basis points over the Russell three thousand, and we're hoping to count. You know, the design purpose of business is to grow cash, unless, of course, you're Musk or or Netflix, which is design purposes to grow your stock price. But most companies, if they're growing their cash and they use a portion of

it to reduce the share count, everybody wins. I want to ask about this idea of stock buy backs, because what happens when a company buy backs buys back the stock but doesn't actually retire the shares. In other words, they just sit there in the corporate treasury for use later on. Perhaps does that matter? Yes, we we don't look at bibe. We look at share count. How many shares are outstanding, what they do, how they got there

is not really relevant. As long as they have more cash than they started at the beginning of the period and their debt asset ratio didn't go up. You know, it's it's companies, uh or if they're doing well, the management likes to reduce the share account because the management then owns a greater percentage of the company, as does every pre existing shareholder. And if they're not growing cash, they probably want to sell stock. Well, Charles, how do

Apple and Google fit into this equation? We know that Apple, for example, has been a poster child of keeping cash offshore and issuing debt to buy back shares simply because they don't want to have to pay the taxes on repatriating some of that cash. So where does that company stand in this whole equation. Well, there, They've been a member of t T a C from the get go, or from when they started doing buy backs, which was

I think after eleven uh, and they remain. I mean, even though they do borrow occasionally, they're debt to asset ratio, they're growing cash so fast that even if they borrow money so they don't have to repatriate, and they're borrowing a very little, very low rate, that they're still in our model. Google, on the other hand, is not doing any share count reduction that I'm aware of, So well they are Well, I personally own Google because they create

their own demand and they're growing cash there. Until they do buy backs, they won't be in the fund. You know. One of the things I thought was interesting is looking at the constituents of t t f S, which is the domestic T T A C T T A C I beg your pardon. The we were We were removed

as subadvisor. They kept the ticker symbol, but we relaunched under a new ticker symbol, trimp TEPS, Folk Drink as T T A C. Okay, So all right, so just so just quickly, this idea of being able to put these companies together eighty five in the new one, how often do they change? Uh? Uh the twenty I'd say, uh have portfolio turnover is the third to a half a year. In other words, we only like the last six months performance if a company stops growing or stops

meeting the criteria. Every day we track each of the three thousand Russell stocks and on our Bloomberg terminal for a listing of which are the top one hundred, and every so often we rebalance and typically h significant number fall out. Yeah, Charles Peterman, thank you so much for

joining us. Charles Peterman as chairman of trim Tab's asset management and he joins us here in our Bloomberg eleven three oh studios talking about his new International Free cash Flow et F. Thanks for listening to the Bloomberg P and L podcast. You can subscribe and listen to interviews at Apple Podcasts, SoundCloud, or whatever podcast platform you prefer. I'm Pim Fox. I'm on Twitter at Pam Fox. I'm on Twitter at Lisa Abrama. It's one before the podcast.

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