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Definition of Fund Investment 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 proposes targeted changes to the current '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 would: simplify the notification procedure; create a framework for the cross-border merger of funds; create a framework for asset pooling; enable fund managers to manage funds domiciled in other Member States; improve the quality and relevance of the key disclosure documents to the end investor; and strengthen 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. 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.
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).
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).
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) |
Types of Investment Fund:(1) Private Funds