A recent settlement order serves as a reminder of how investment
strategies using derivatives can produce unanticipated results. In
this case, the results led to undisclosed returns of capital and a
$6.5 million civil penalty. The case illustrates the importance of
instituting regular communications among portfolio managers, risk
and compliance officers, attorneys and accountants, so that the
results of an investment strategy are fully anticipated.
Swaps and Taxes
I am not a tax attorney, so the following is not tax advice. Any
inaccuracies only emphasize the need for the measures discussed at
the end of this post.
The fund involved in the settlement "disclosed that income
would be generated by, among other means, the Fund 'active[ly]
manag[ing] duration and yield curve exposure' of its debt
portfolio, which ... consists of income-producing debt securities,
including interest rate swaps." For several years, the fund
engaged in a strategy of pairing current and
