Advantages of Offshore Funds for Investment

Foreword
There are a number of reasons why an investor might find and offshore investment fund attractive and the following is a summary of those which are most commonly quoted.

Possible Taxation Benefits
As previously mentioned, offshore centres are either low or not tax centres and as a result, funds which are created in an offshore centre will not be subject to tax, either in respect on income earned or on capital gains which are realised within the scheme. Funds can therefore build up tax-free profits which can in return be re-invested.

In addition, investors will not be liable to local capital gains tax on the disposal of units nor will they be subject to the deduction of withholding tax on the payment of income distributions.

Offshore funds provide planning potential as capital or income remittances could be delayed and made at times which would be favourable to the investor, the scope for tax deferral is one of the main reasons behind the growth in the offshore fund market.

Despite the possible tax benefits which offshore funds can provide, it should always be remembered that it is the tax position of the investor which will determine jus how advantageous this typo of vehicle could be.

Potential for Greater Returns
In view of the fact that the income and profits of the fund will generally be free from tax in the offshore centre where the fund is based, all the profits and income generated can be re-invested which creates greater potential for higher rates of return compared with onshore funds which are subject to local taxation.

Investment Strategies
High risk assets cannot generally be held in onshore funds in the light of fund regulations which exist. However, there are fewer restrictions concerning the types of asset which can be held in offshore funds and as a result 'riskier' assets, such as real estate, commodities, futures and options, can be included in offshore portfolios. This, in turn, increases the scope for higher returns although as the reader / client will appreciate, with risk comes the danger of making losses!

ADVANTAGES OF OFFSHORE INVESTMENT FUNDS FOR PROMOTERS

Offshore funds not only provide potential benefits for investors but they also provide possible advantages for the promoters.

Regulation
Usually, the regulation of offshore funds is more flexible and less onerous than the regulations which govern onshore. This can create greater investment opportunities.

Taxation
There could be tax advantages which may be available to investors and the likelihood that offshore funds will not be subject to taxation in that local centre. The potential for greater returns helps offshore funds attain more efficient economies of scale than they could achieve onshore.

Increased Revenue
In view of the possibilities of higher returns the promoters of offshore funds may be able to charge higher fees that they could charge if they were offering onshore funds. In addition, the relaxed regulation which exists in some offshore centres reduces the cost which would otherwise be incurred to meet the level of supervisory requirements which are imposed on most onshore jurisdictions.

THE REGULATION OF OFFSHORE INVESTMENT FUNDS

Where the fund has been created, or more importantly where the management or administration of the fund is carried out, will determine how the fund will be regulated. Not all offshore centres have legislation win place which regulates these type of vehicle but in those centres which have imposed regulatory controls, it would be usual to find different classes of funds available and different rules applying to those classes.

Authorised Funds
These are funds which can be freely marketed to investors in a variety of different countries, including some which are onshore.

Restricted Funds
These are funds which have a restriction in respect of where they can be marketed.

Usually, a local trustee and manager will be required and both would have to be 'authorised' to act in accordance with local requirements To be 'authorised' the trustee or manager would have to be the holder of a licence (such as an investment licence or bank/trust company licence).

Exempt Restricted Funds
These are funds which have less than a certain number of participants (e.g. 50) and in view of this ownership restriction they are not subject to the same controls as restricted funds. Neither the trustee nor the manager of an exempt restricted fund will require a licence to act.

Closed-ended Companies
Usually, investment trusts are not regulated by offshore centres as they are publicly quoted investment funds. However, permission for the creation and administration of the fund might have to be obtained from the regulator in the centre chosen.

GENERAL MARKETING OF INVESTMENT FUNDS

Although relaxed regulatory controls can be an advantage to promoters, administrators and investors alike, it can create problems if there is the desire for the fund to be marketed outside the offshore centre and in particular, if the fund is to be marketed in onshore centres.

Generally speaking, onshore centres will only allow funds to be marketed locally if those funds meet the regulatory requirements of that centre. This effectively excludes the majority of offshore funds as the level of regulation will be less than that which is expected and required onshore.

However, there are opportunities for offshore funds to market themselves in some onshore regions.

MARKETING OF OFFSHORE FUNDS IN ONSHORE CENTRES

Although it is not possible to market an offshore investment fund in the USA (it is not even permissible for a US citizen to invest in such a fund), in certain circumstances it is possible for an offshore fund to be marketed in Europe, provided that is so authorised.

UCITS
The Undertaking for Collective Investment in Transferable Securities (UCITS) was a European Union initiative which intended to harmonise the regulatory controls of EU member states with the objective that collective investment funds could be freely marketed between those member states.

There are a number of requirements which must be met before a fund can qualify as a 'UCITS fund'. The main ones are as follows:

• The assets must be held by a custodian who is authorised to act in this capacity in the centre where he is based;

• The investments in the fund must be transferable securities listed on a recognised stock exchange;

• It must meet certain reporting and liquidity requirements.

These funds must be set up in an EU member state, a fact which excludes the vast majority of offshore funds except those which are established in the Dublin International Finance Centre, Luxembourg or Gibraltar.

The UK Provisions and Designated Territories
A number of offshore funds can, however, be marketed in the UK as a result of Section 87 of the UK Financial Services Act 1986. Under this section the Secretary of State may allow certain Designated Territories to market their funds in the UK on the basis that the fund regulation in those territories meets the regulatory requirements of the UK.

Bermuda, Guernsey, the Isle of Man and Jersey are, at the time of writing, designated territories.

It is also possible that funds from countries which have Designated Territory status may be allowed to market in other onshore centres (apart from the UK) on the strength of the fact that their regulatory requirements meet UK standards. In such cases the fund wishing to market must seek authorisation in the country or countries concerned but there is no guarantee that permission will be granted.

INVESTMENT STRATEGIES/TYPES OF FUNDS

There are a wide variety of investment funds to choose from and the following will give you an indication of the type of underlying investment strategies which different funds may choose and offer.

Single Class Funds
This type of fund will only have one class of investor (unit holder) and only one underlying investment portfolio.

Multi-Class Funds
Although there may only be one underlying investment portfolio, there will be different classes of investors (unit holders) and perhaps some receiving income distributions and others receiving units instead of income.

'Hub and Spoke' Funds
Also sometimes referred to as 'master and feeder' funds, this type of vehicle has two tiers. Firstly, there is the master fund which is aimed at high net worth institutional investors. Secondly, there is the feeder fund which invests in the master fund and is made up of investors who did not have sufficient capital to buy into the master fund as of right and they have had to combine their subscriptions to meet the necessary criteria.

Exotics
Basically, this type of fund is aimed at investors who are precluded from investing directly into specific types of investments. Instead, the fund buys those holdings which the investor would be unable to hold in for his own account.

Equity Funds (Common Stock Funds)
As the name suggests, such funds only invest in equities, usually from a particular country. Often these funds are geared to capital appreciation.

Fixed Interest Funds (Bond Funds)
In this case the underlying investments will be fixed interest holdings, either government issues or debentures issued by corporation. Often the strategy would be high income return. These are sometimes referred to as 'income funds'.

Commodities / Derivatives
These are high risk but there is a possibility of high capital rewards.

Tracker Funds
These are sometimes called index-linked funds and comprise investments which are chosen from a particular stock exchange index. The objective is that the underlying assets will perform as least as well as the market indices.

Realty Funds
As the name suggests, such funds hold real estate which can create considerable capital gains but on the other hand, because of the nature of the assets, they do carry high risk and are also very illiquid.

Balanced Funds
These have a mixture of equities and fixed interest holdings designed to provide a balance between income and capital growth.

Money Market Funds
These are funds which hold short-term instruments of the money market, such as certificates of deposit and treasury bills.

WHICH OFFSHORE FUND TO CHOOSE

This is, of course, down to individual choice although there are a few areas which a prospective investor might want to consider as part of the selection process.

Regulation
The Investor should decide whether to place his assets in a fund which is administered in a regulated offshore centre or in a fund which is administered in an unregulated centre. The risk/reward ratio would be a key factor in deciding which centre to choose for the investment.

Reputation of the Service Provider
The investor should check who will be providing the various functions which are required under the structure. In particular, he should feel comfortable with the companies or institutions who will be acting in the roles of trustee, manager and custodian.

Some offshore centres have a relatively new fund industry whereas other centres have a developed fund industry with a high level of local expertise.

Marketability of the Fund
Some investors might prefer a fund to be widely marketed and as a result, might want to invest in a UCITS fund or in a centre which has designated territory status (if the UK is a key market area).

Taxation
There may be tax advantages if the client invested in a roll-up fund rather than in a distributor fund.

In addition, the client should consider whether his tax position would be improved if he invested directly into securities and equities so as to take advantage of double taxation treaties which may exist between his country of residence and other onshore (and possibly offshore) centres.

Investment Policies
Some offshore funds have aggressive investment policies geared to capital growth, whereas others have a more conservative approach.

Cost
The investor should check what the fund is likely to cost in terms of market price and also any subsequent fees to the managers.

The price movements of the fund over a reasonable period of time could be reviewed to ascertain whether there had been any major variances and if so, enquires should be made as to why these variances occurred.

If it is a unit trust, the investor should also check the fee structure of the fund as often offshore funds will be more expensive than their onshore counterparts. Some also have an arrangement under which the initial fee is rebated or part-refunded to the investor.