OFFSHORE INVESTMENT FUNDS

Foreword
· Like in other sections, this section brings to the reader / client's attention the workings of offshore investments funds. For ease of reference complicated words and day to day jargon has been replaced with everyday words than can be understood by everyone. The reader / client will gain knowledge of each type as well as a basic understanding of the possible advantages in establishing a fund in an offshore jurisdiction, as well as considering the roles of the trustee and the manager and also have a look at the roles of the other parties who will often be required.

Definition
An investment fund is a vehicle which holds a number of different investments. Investors are given the opportunity to invest in the fund by providing cash in exchange for a share in the underlying investments. Investors would not, hoverer, receive a direct share of each stock held but would instead be given a share of the fund itself (often called a unit) which would comprise a proportion of all of the underlying investments held. Investors can therefore acquire an interest in a wide variety of investments by purchasing units in an investment fund.

For a fund to be classified as 'offshore' it would usually have to be operated from an offshore centre. This would normally require the management or administration to be conducted from an offshore centre.

OPEN-ENDED OFFSHORE INVESTMENT FUNDS

Investment funds are usually classified as being open-ended or closed-ended. Open-ended funds can be created as a unit trust, as an open-ended company or as a mutual fund. Together, they are sometimes referred to as collective investment schemes.

Unit Trusts
This is a type of trust. The promoter (who wants to create the fund) will be the settlor who executes a trust deed which will set out how the fund is to operate. A trustee and manager will be appointed. The trustee will be responsible for safe keeping of the assets and for ensuring that the terms of the trust deed are followed. The manager, who will often be the promoter, will be responsible for the day-to day administration of the fund and will report to the trustee. The trust property will represent the funds which have been received from the investors and the investors themselves will be the beneficiaries, although their interests will be in proportion to the funds which they have invested.

The role of the trustee
The duties owed by the trustee of an investment fund are similar to those owed by the trustee of a private or pension trust. In most unit trust the day-to-day administration of the fund will be conducted by the manager and as a result, the trustee will expect the manager to perform the duties which he would otherwise be responsible to fulfil.

The trustee should satisfy himself that the manager is fit an proper to act in this capacity and that the fond is administered in accordance with the trust deed and any other regulations which may apply in the offshore centre.

The trustees will be required to take control of the unit trust's assets and to be registered as their legal owner. He will have the power to appoint agents (such as bankers) to assist him with the proper and effective running of the fund and he will usually place the management of the investments with the manager who he has appointed. In some cases a trustee will also appoint a custodian to hold the underlying investments.

The trustees will also be responsible for checking the price and method of pricing of the fund and will oversee the distributions which are made to the investors. He will sometimes be responsible for maintaining the register of unit holder although this would usually be delegated to a registrar or custodian.

Usually, the trustee will be a corporate body who is approved to act in this capacity by the regulatory authorities in the offshore centre where the fund is based. The criteria for approval to act as the trustee will vary between centres but often a capital adequacy test is applied to make sure the corporate body has sufficient financial standing to act as trustee. Often an international bank will be appointed to fulfil this role. The position will usually require a licence which is issued by the local regulatory body.

The role of the manager
The manager will be under a duty to administer the fund in accordance with the terms of the trust deed as well as in accordance with local regulations which may apply to the unit trust. In view of the responsibilities which this will involve, the trustee should carefully check the suitability and expertise of the intended manager before proceeding with the appointment.

In addition to advertising on the investment, the manager will also be responsible for making a market in the units of the trust and will be involved in selling units to the initial investors, eventually buying them back and then re-selling them to new investors. The manager will also advise on the possibility if issuing new units from time to time.

Usually, the manager will be a company which is incorporated in the offshore centre and will perhaps be owned by an overseas bank, insurance or investment company. The requirement that the manager be a local company enables the authorities in the offshore centre to have so jurisdiction over its activities.

Other parties
In addition to the trustee and manager, a unit trust will usually have other parties who will perform specific functions as follows:

Trust expenses
The trust deed will usually contain fee charging provisions to enable the trustees to charge a fee for their services. Such provisions will also cover the payment of auditors expenses and fees of the registrars and will also enable the trustee to cover the cost of any legal advice which he may require on the structure.

The manager's fees will also be covered in the deed. Usually he will receive an initial fee (which is calculated on the value of the funds paid into the unit trust) plus an annual management fee which normally be calculated on the market value of the fund.

The manager will also receive remuneration for his role in market making which will be the spread between the bid and offer prices. The bid price is the price at which the manager will buy units and the offer price I the price at which he will sell units.

Types of offshore unit trust
There are two main types of offshore unit trusts;

Many investors prefer to invest in roll-op funds. If no dividends are paid, income tax will not be an issue for the investor and if there is any capital gains tax (or equivalent) to pay , it will be deferred until such time as the units are sold. However, some onshore centres, such as the UK, have introduced legislation which has reduced the taxation benefits previously offered by roll-up funds by making the disposal of units a chargeable event for income tax purposes.

Open-ended Companies
This type of fund is similar in some respects to a unit trust. It will own a basket of underlying investments and investors will be able to buy units in the vehicle, thus giving them exposure (through indirect ownership) to a wide base of different holdings.

However, an open-ended company, s the title suggests, is a corporate vehicle and will therefore have the general features of a company. As such it will have a separate legal identity and can continue in perpetuity. Instead of units, this vehicle will issue redeemable shares and there will not be a trustee controlling the fund as the management and control will be vested in the directors. Finally, there will not be a trust deed as the memorandum and articles of association of the company will govern the fund.

As this type is a corporate entity it will only be available in those centres which have the required company legislation to permit such a vehicle to exist.

The structure
The directors will usually appoint a management company to assist with the administration of the company and possible to manage the investments. They may also be involved with the preparation of accounts and valuations and the maintenance of the statutory records, although often an accountant will be appointed to assist with the preparation of financial information

A custodian may be appointed to handle the custody of the investments and cash assets. The custodian may also be involved in the settling of trades which are placed within the fund.

In some instances the custodian might be referred to as a 'custodian trustee' and the function which is performed by the management company might be referred to as 'third party fund administration'.

The directors are often appointed by the prompters or if the promoter is, for example, an international bank, the directors might be senior officials of that bank.

The management company will usually be a company which has been incorporated in the offshore centre chosen for the fund and the custodian will usually have to be approved to act in such a position by the local regulatory authority. It is possible that the custodian might have to be a locally incorporated company. Regulatory issues will support the issue.

The company will usually issue redeemable shares which will also be participating shares, thus enabling investors to receive profits. Usually, these shares will not carry voting rights although some funds do permit investors to vote.

In addition, the company will often issue founder shares, usually to the promoters or the management company, which will generally have voting rights but no rights to participate in the profits of the company. Such shares are not usually redeemable, in some finds the founder shares do not have voting rights

The management company may also hold nominal shares which are used to replace the par value when redeemable shares are redeemed.

Some offshore funds have a stock market listing in certain onshore centres (e.g. London) but this can be an expensive process and such funds are generally only traded through markets which are made by the managers.

Mutual Funds
These are similar to open-ended companies and where development in the USA. They have a similar structure to open-ended companies as mentioned, indeed open-ended companies where in fact modelled on the mutual fund vehicle, and are aimed primarily at the US dollar market.

Offshore mutual funds are predominantly offered in Caribbean offshore centres, such as the Cayman Islands, but like all types of offshore investment funds covered earlier, they cannot be sold to US citizens as they are not authorised investments in accordance with the requirements of the Securities and Exchange Commission.

These are funds which do not offer redeemable shares and are commonly known as investment trusts.

Structure
The structure will be similar to that mentioned for open-ended investment companies. The directors will be responsible for the management of the company and they will usually appoint a management company to administer the fund. The administrator will usually be responsible for the holding the assets and will perform a function similar to that of custodian.

The popularity of closed-ended funds has, in the main, been built on the ability of such vehicles to borrow and go gear up. This creates greater potential for higher returns although there is also the risk for the fund making a loss as borrowing and gearing are speculative actions.

Pricing
The pricing of closed-ended investment companies is similar to the pricing of the open-ended funds in that the key factor is the value of the underlying investments in the fund (often referred to as the Nat Asset Value). However, other considerations must also be taken into account, notably the supply and demand of the shares.