Definition
of Fund Investment |
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Fund
investment is suitable for an investor who wants to
be able to choose to invest in a particular classification
of assets (eg London shares, US property, Russian energy
companies, or rock singers' earnings streams), without
having to study the characteristics of the individual
assets. Private bankers, trust managers or other advisers
often direct some or all of their clients' assets towards
fund investments.
Fund
investment spans the gamut of riskiness (and reward)
from ultra-safe, low-yielding bond funds at one extreme
to highly-leveraged derivative hedge funds at the other.
As with other types of investment, governments in high-tax
countries have constructed a regulatory framework which
reduces both risk and reward, so that investors in search
of high returns are more or less obliged to look offshore.
If
direct equity investment is the fastest-growing investment
sector, then fund investment must take the palm for
diversity. Funds began as a safe and somewhat tax-privileged
way of encouraging ordinary citizens into stock-market
participation, the idea being to encourage saving while
at the same time deepening the liquidity of stock markets.
But unit trusts (UK) and mutual funds (USA) began an
evolution which soon took them into uncharted waters,
and the more generic term investment funds includes
both the highly-regulated kind of fund typified by the
EU's UCITS legislation, and the sharp-toothed international
tigers so hated by regulators and control-freak national
leaders.
UCITS
(= Undertakings for Collective Investment in Transferable
Securities) is a harmonised EU regime which allows a
fund to be marketed into all EU countries if it conforms
with the requirements of the EU UCITS Directive. Increasingly,
public investment funds in the EU attempt to fall under
the UCITS legislation, for obvious reasons. A number
of offshore jurisdictions within or associated with
the EU have created legislation which accommodates UCITS-conforming
funds. These include Luxembourg, Jersey and Guernsey.
While
it is true that onshore investment funds cover a wide
range of investment targets, the UCITS legislation allows
only for listed securities to be purchased, and in Europe
at any rate national markets are too small in most cases
for adequate distribution of more specialised funds,
which are in any case hampered by national regulatory
carapaces.
In
November 2006, the European Commission published a white
paper which proposed targeted changes to the 'UCITS
Directive', which, it argued "does not adequately
reflect the challenges facing the industry today and
can give rise to unnecessarily high compliance costs
and missed investment opportunities".
The
proposed changes had the aim of: simplifying the notification
procedure; creating a framework for the cross-border
merger of funds; creating a framework for asset pooling;
enabling fund managers to manage funds domiciled in
other Member States; improving the quality and relevance
of the key disclosure documents to the end investor;
and strengthening supervisory cooperation to monitor
and reduce risk of cross-border investor abuse. The
white paper also proposed a review of options for establishing
a European 'private placement regime', allowing financial
institutions to offer investment opportunities to qualified
investors across the EU.
Then
in March 2007, the EC published a consultation on the
proposed changes to the UCITs directive, with the
aim of finalising its formal proposal
by the end of that year.
Internal
Market and Services Commissioner Charlie McCreevy announced
at the time that:
"The
UCITS Directive has served the European fund industry
well. It has been the springboard for global leadership.
But the industry is faced with massive structural challenges
– fragmentation, complex distribution channels,
competition from new investment products. The current
Directive provides no answer to these challenges."
"That
is why I have pushed hard to strengthen the Single Market
framework for funds. The November White Paper agreed
the steps that were most urgently needed. This consultation
marks the beginning of the delivery phase. I invite
stakeholders to comment critically on the usefulness,
coherence and cost-effectiveness of our preliminary
ideas. This will ensure that the Commission's subsequent
proposal will really deliver better outcomes for European
investors and market participants."
In
the meantime, however, there has been a drift both for
listed and unlisted funds towards offshore, and also
in the case of the US, towards the limited partnership
model, in which a group of investors can obtain the
investment power that comes from volume while retaining
individual tax treatment. Some offshore (and onshore)
jurisdictions distinguish between large and small groups
of investors, providing a much more relaxed regime for
funds with fewer than 50 investors (partners).
As
with equity investment, the first decision any fund
investor ought to make is where to base his investments.
Probably, few investors actively consider this question
until it's already too late, and the tax damage has
been done. That's understandable if investment begins
with a few thousand dollars or equivalent, almost as
a hobby, and gradually builds up. The investment range
we are dealing with here is bigger (from $100,000 to
$5m) and forethought is essential if more than $100,000
is to be put into funds.
The
introduction to this section contained some general
comments on the choice of onshore v. offshore; the decision
where to base fund investment does not necessarily have
to follow the general decision, and the different tax
profile of fund investment may require that it doesn't.
Thus, low-yielding capital roll-up funds held for the
long-term are a capital gains tax problem, not an income
problem, whereas income funds are the reverse.
There
is a vast range of individual situations, and this section
will concentrate on finding and buying investments,
rather than on location. See the investorsoffshore.com
DIY investment selector for investment guidance
based on specific residential and investor profiles.
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Types of Investment Fund:(1) Private Funds
Most
fund investors will want to choose public funds (see
below) because of the liquidity and flexibility they
offer, but some people with a longer-term horizon and
somewhat greater assets may prefer a private fund.
In
essence, a private fund, which is usually a 'closed-end'
fund (ie it runs for a pre-determined number of years
and is then terminated), is set up among a group of
up to 50 people, each contributing a significant amount
of money (it wouldn't normally be less than $1m each)
and invests into a particular class of assets. The advantages
are that professional managers can use their specialised
knowledge of the selected asset class to obtain higher
returns than can be expected from public funds, which
are often listed, usually open-ended, and almost always
constrained by regulation, even in offshore jurisdictions,
which normally apply some prudential rules to listed
funds, even if these are weaker than those applied in
high-tax countries.
Many
offshore jurisdictions provide the necessary legal infrastructure
for private, closed-end funds to operate, usually via
limited partnerships or limited liability companies.
Both of these structures permit tax transparency in
key investor bases such as the US. The offshore company,
or partnership, is of course lowly-taxed in the first
place, and its individual members or partners can receive
their profits without the interposition of corporate
taxation.
The
regulatory regime for closed-end private funds is usually
much more relaxed than that for public funds, on the
grounds that the investors concerned, being richer,
need less protection, and are perhaps wiser into the
bargain.
Further
information about the regulation and taxation of private
offshore funds is available in www.lowtax.net,
in Offshore
Business Review, and in various sections of individual
jurisdictions (Forms of Company, Offshore Business Sectors,
Offshore Legal and Tax Regimes, and Law of Offshore).
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Types of Investment Fund:(2) Public Funds
Most
investors will not want to take on the long-term commitment
implicit in private fund investment, and will instead
prefer the liquidity and transparency of public funds.
Whether or not a public fund is listed (and most are)
the regulatory regime of any jurisdiction that accommodates
public funds requires frequent and public valuation
(nav's), and an open-ended structure in all but rare
cases.
Unlike
equities, which have predominantly maintained their
listings on stock exchanges in high-tax countries (because
of the liquidity), public mutual funds are often based
in offshore jurisdictions, even though their investment
targets are not. Offshore-based funds are therefore
a good surrogate for end-investments in most investment
classes, because most offshore jurisdictions give funds
a pass-through in tax terms, and can often use double
tax treaties to reduce effective tax rates to low levels
- something that would not be available to a private
investor unless he resided in the offshore jurisdiction
concerned, and in many cases not even then - or at any
rate, only with a great deal of hassle.
Further
information about the regulation and taxation of public
offshore funds is available in www.lowtax.net,
in Offshore
Business Review, and in various sections of individual
jurisdictions (Forms of Company, Offshore Business Sectors,
Offshore Legal and Tax Regimes, and Law of Offshore).
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How
To Make Offshore Fund Investments
Just
because mutual funds, public ones at any rate, are to
some extent sanitised investments, there are plenty
of hurdles in the way of marketing offshore funds into
high-tax areas. For an offshore fund to be marketed
in high-tax countries, it usually has to conform with
local prudential rules (eg the UCITS directive in the
EU, and any subsequent legislation) and in practice
this means that it cannot offer very interesting returns.
As
with private banking, it is not that it is illegal for
a citizen of a high-tax country to buy 'unrecognised'
offshore fund units - it is illegal for the fund to
advertise in the high-tax area, and it is illegal for
the citizen to hold fund assets without declaring them
and paying tax on the gains from them. If a resident
of a high-tax area unilaterally contacts an offshore
fund, nothing nowadays prevents a transaction from taking
place quite legally (decades ago, exchange control regulations
would have prevented it).
Residents
of high-tax areas who plan to remain there, and to pay
their taxes, may still find it beneficial to invest
in offshore funds because the funds operate in a less
taxed environment than onshore funds, and will grow
quicker; but most investors in offshore funds will be
trying to optimise taxation directly.
As
explained in Who Can Benefit
From Offshore Investment, in order to optimise taxation,
it is necessary either to have residence in a low-tax
area, or, for a high-tax resident, to have an offshore
structure that distances income and capital gains from
the investor's domestic tax regime. Either way, the
ownership of fund assets is going to be offshore, and
the main question is, where to base it?
The
choice of an offshore jurisdiction is in itself a difficult,
and to some extent a circular task. You will not find
it easy to distinguish between the merits of different
offshore jurisdictions, or the facilities they offer,
until you have got to know them quite well. This is
the point at which you might think that an onshore adviser
in your own home country can help you - and it may be
so, but remember that only a very skilled, knowledgeable
and above all, objective, adviser is going to be useful.
Such a person is hard to find.
www.lowtax.net
is designed to help people who do not have access to
the perfect adviser we just described. www.lowtax.net
is not an investment adviser, and is no substitute for
professional advice, which is an absolute necessity
for anyone planning a move offshore. But the www.lowtax.net
site does contain a wealth of information about 35 offshore
jurisdictions, which is designed to help you to make
a preliminary choice of one or a few offshore jurisdictions
suited to your circumstances, which you can then explore
in depth.
The
choice of an offshore jurisdiction as a base needs to
be guided mostly by your own particular circumstances,
but if investments are to be made into funds (or companies)
listed offshore, or if an offshore brokerage is to be
used, then these aspects need to be borne in mind when
making a choice.
Purely as a factual guide,
here is a list (in alphabetical order!) of those offshore
jurisdictions with developed mutual fund regimes; in
most cases, this also means that they have stock exchanges
(an SE in parentheses) and, you may want to assume,
a fairly high level of sophistication in terms of investor
protection:
Bahamas
(SE)
Bermuda (SE)
British Virgin Islands
Cayman Islands (SE)
Cyprus (SE)
Guernsey (SE)
Hong Kong (SE)
Ireland (SE)
Luxembourg (SE)
Malta (SE)
Mauritius (SE)
Netherlands Antilles
Seychelles
Switzerland (SE)
Turks & Caicos Islands
www.lowtax.net
has information on the stock exchanges and the regulatory
regime for each of the above jurisdictions. Our section
Gateways To Offshore Information
Providers will lead you to further sources of such
information.
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