Exploring the Funds Hub

Whilst there is clearly a cacophony of different issues for him to tackle, it did remind me of this excellent article in Reuters back in October which was already tracking the moves being made in the investment funds industry to continue the meteoric rise of ESG investment strategies.

For those that are very late to the party, ESG stands for environmental, social and governance and the story of ESG investing actually began back in January 2004 when former UN Secretary General Kofi Annan wrote to over 50 CEOs of major financial institutions, inviting them to participate in a joint initiative under the auspices of the UN Global Compact and with the support of the International Finance Corporation (IFC) and the Swiss Government. The goal of the initiative was to find ways to integrate ESG into capital markets.

Whilst the concept has become an undoubted success, getting it to this position has not been without challenges. Ignoring those that thought ESG might just be something of a fad, one of the more interesting issues came from institutional investors who argued that making investment decisions on the basis of these principles was actually a breach of their fiduciary duties to their shareholder base.

This has caused extensive debate, but a strong argument was being made in many circles that the pursuit of financial gains should always be the sole focus. It became litigious in a number of jurisdictions, where investment managers were challenged on both their principles and ethics, although in almost every case, it was where the financial gains had not matched the expectations of the investors.

But both the UK and the EU decided to take this out of the hands of the courts and the new disclosure requirements for investment managers and advisers with respect to their ESG policies will apply in the European Union from 10 March 2021 and new climate-related disclosures will apply to investment managers under a UK disclosures regime that is expected to be phased in from 2022.

We will ignore the impact of Brexit for the purposes of this short article, but it does appear that all of Europe is united on this front. What is interesting to watch is that the regulatory landscape in this area is undoubtedly evolving and when you add these new initiatives to the Shareholder Rights Directive, the UK Stewardship Code, the Principles for Responsible Investing and the UK Corporate Governance Code, it is now the case that European managers will be operating within these parameters indefinitely.

Figures show that assets in sustainable investment products in Europe are forecast to reach €7.6 trillion over the next five years, which will then outnumber conventional funds. Part of this drives comes from a critical mass of pension funds and insurers deploying capital exclusively to asset managers with ESG capabilities.

Whilst this level of market dominance has not yet been reached in the US, largely due to some of the scepticism highlighted above, the clearer path that the Democratic party now have in the US may well see their domestic capital providers follow a very similar path, especially in a market with greater maturity that really is looking for a transformation for the better.

This article was originally published by funds europe.

One of the most common scenarios we encounter is a US-based manager who initially establishes a domestic fund to attract US taxable investors. With the performance going in the right direction, the manager begins to think about US tax-exempt investors, such as charities, pension funds and university endowments, as well as investors based outside of the US, who like the track record and want to invest.

They have probably then been made aware that they will need an offshore vehicle and now have the task of working out why, where, and how much they need to spend.

Why do I need one of these?

US tax-exempt and non–US investors will want to avoid potential US tax exposure that could result from direct investment into your US vehicle and so they will want to come into an offshore "blocker" vehicle. To ensure you can take in their capital, you will need to add at least one offshore structure to form either the traditional "master-feeder" or the "mini-master".

What is a master-feeder?

Here, we will create two new offshore vehicles. Your existing US fund will then contribute its assets into the offshore master fund upon the launch of the new structure. The offshore feeder vehicle will then be available to take in US non-taxable investors and the non-US investors and "feed" into the offshore master fund as well, allowing for a co-mingling of all of the invested capital in the most tax efficient manner.

Sounds good, so what about the minimaster?

In a mini-master structure, a single offshore fund is established which is taxed as a corporation to benefit US tax-exempt investors and block UBTI for non-US investors.

Adding a single offshore vehicle saves cost and therefore has proven popular with startup and emerging managers. The offshore fund invests directly into the existing US fund, which will then act as the master fund (whilst remaining the fund into which the US taxable investors will continue to invest).

This provides an additional benefit of not requiring the ownership of the assets of the domestic fund to be transferred. This reduces the administration around the restructuring and subsequently the cost as well. While there are some tax consequences to be discussed (and some investors may not want to invest even indirectly into a US vehicle), it has proved to be appealing to those looking to keep it as simple as possible to begin with.

Okay, so I need one of these structures. Where do I choose to set it up?

The British Virgin Islands and the Cayman Islands are both highly suitable and well-regarded offshore fund jurisdictions that have been used for many decades and always strive to meet the requisite international standards. We have long-standing clients who elected to use one or the other for different and highly sensible reasons at the time of their first launch. But there are differences, and a number of our clients have fund vehicles in both jurisdictions to maximise the advantages that they each offer.

Understood. But how do I choose the best one for my fund?

Cayman is the world's most popular offshore funds jurisdiction. We estimate that Cayman has over 70 per cent of the world's offshore funds and so is the well-trodden path. Although the BVI has around 15 per cent, managers who opt to establish their funds in the BVI sometimes encounter the additional question from institutional investors of "Why BVI?". Whilst there are very reasonable and logical answers, the selection of Cayman removes this additional query in the DDQ.

But I am also looking to minimise cost…

In terms of corporate and regulatory costs, Cayman is a significantly more expensive jurisdiction than the BVI, both upon formation and for the annual maintenance of the vehicle(s). This is then compounded by the greater regulatory requirements in Cayman, which result in the cost differential for the jurisdictions being substantial.

For this reason, many fund managers who are operating with a relatively low level of AUM prefer to establish their offshore fund in th...

Here is a way to start an article like no other; what a fantastic year 2020 has been. The obituary of the hedge fund industry has been written many times, but for some, it was written in indelible ink in 2008 following the financial crisis. Commentators blamed the industry for its part in the global collapse, notwithstanding the fact that a huge majority of fund vehicles during that time were actually victims themselves. Ignoring the huge layer of red tape that subsequently encased the industry, this wasn't actually the largest cause for concern.

The bigger problem was that once the S&P settled down, its solid and consistent performance led to a benchmark that the industry simply couldn't match. Many funds struggled to provide the exceptional returns they were once capable of and with new products like exchange-traded funds combining performance with a lower risk profile and lower fees, the glitz and glamour of AW Jones' product had truly been eroded. However, the inflow of investment remained, and while the lack of true performance caused general resentment, a shock to the global financial system might cause the passive investment models to fail and suddenly the two and 20 would look like money well spent. So the script for 2020 couldn't have been better written by Hollywood, although probably would have had a little more Dwayne Johnson. The flash crash in March could have lead to the industry flourishing from that point forward.

Dog funds

Sadly, a record 150 funds were classed as poor performers in the "Spot the Dog" list compiled by wealth manager Tilney Bestinvest, which names and shames the worst-performing investment funds and reported a 65 per cent increase in the number of "dog" funds, up from 91 in February. Interestingly, this is consistent with the tough time value investors have generally had over the last decade. Buying shares in companies which appear cheap given their fundamentals became a true art form, but the markets simply haven't played to the same rule book and one obvious explanation for this is the rise of tech firms, which are simply impossible to analyse using standard valuation tools. Brand strength and user adoption models seemingly become far more important than the profit line, for example. With a pandemic forcing the entire planet to go online simultaneously, the arguably overvalued tech stocks somehow continued to grow exponentially.

Those companies that remained well placed to increase in value consistently if the world had continued on its "normal" course, suddenly found that the very solid foundations they were sensibly built on were destroyed from under them. Hugely dependable industries were decimated in a matter of months which even the very best minds in the hedge fund industry couldn't readjust to quickly enough. Where you have such a fundamental and novel shock to the system, the largest funds will always have the biggest problem with turning their tanker around. Just looking at the Top 20 Dogs, all but one of them is over a billion and you can see some truly institutional names. On a wider basis, the ten largest hedge funds reporting to eVestment remain some 4.61 per cent in the red year-to-date, despite posting a 1.31 per cent gain in July. In contrast, hedge funds overall are now flat for the year, having registered a 3.43 per cent rise in July to successfully claw back losses suffered in H1.

Market neutrality achieved? Being nimble and able to pivot in this type of market was always going to be advantageous.

Digital rise

From our own anecdotal evidence, given we have the pleasure of working with a large number of emerging managers, we certainly have clients who are putting some very significant numbers up on the board this year. It has been especially noticeable in the digital asset slice of this market. Whether you believe in the digital gold theory of bitcoin or not, there is no doubt that with so much uncertainty out there, investors are looking for interesting alternatives to ...

The market for US dollar (USD)-denominated funds in Greater China has undergone rapid transformation. Professional services providers have been grappling with the impact of a flurry of new laws and regulations, while fund managers have suddenly found themselves overwhelmed by choice. This has led some to question whether market convergence has finally led to the creation of a level playing field for all jurisdictions, or whether in fact this is the beginning of widespread divergence in the fund market industry.

This article explains how and why the market has blossomed in recent years, and considers how it may develop in future.

USD fund market outside mainland China

The USD fund market outside mainland China has flourished due to the emergence of free markets such as Hong Kong, in tandem with the tight capital controls maintained by China. These controls have laid the foundation for China's economic evolution in the past 40 years, which have seen the confluence of international asset allocation, pensions and endowments on the one hand, and the emergence of ultra-high-net-worth individuals, domestic insurance funds and a burgeoning asset management industry on the other.

This dichotomy of two markets - domestic and international - created a real need for offshore vehicles so that USD capital could be pooled and invested, and investment returns distributed in a tax-efficient way. This in turn smoothed the way for the widespread recognition of the Cayman Islands and its investment-holding and fund products, such as exempted limited partnerships for private equity funds, exempted companies as mutual funds and certain non-fund arrangement vehicles.

International standards and rule books

The coordination of international standards and rule books for the fund management market was led by the Organisation for Economic Cooperation and Development (OECD), the Financial Action Task Force (FATF) and, to a certain extent, the UK government. The financial services industry has been beset by "regulatory fatigue" since 2015, as it has got to grips with heightened scrutiny of anti-money laundering and counter-terrorist financing and proliferation measures, and with new requirements governing the exchange of tax information (automatic, spontaneous or on request). At the same time, it has had to deal with new requirements governing economic substance, data collection and transparency in beneficial ownership, as well as measures to safeguard fund assets and heightened oversight of virtual asset issuers and service providers.

The sheer volume of regulatory changes in recent years has certainly felt overwhelming, but it is also necessary to consider how the market has responded to the resurgence of neo-liberalism, and the free flow of capital and free movement of people across borders. The answer may be moot, but governments and regulators have made substantial progress toward establishing a mutual framework for information-gathering and exchange, as well as behavioral standards to which fund managers must adhere.

While this convergence has been taking place, many individual jurisdictions have quietly been re-designing their tax regimes to make them clearer, friendlier and more flexible. As just a few examples:

Hong Kong has established the Unified Fund Exemption Regime and introduced a much-anticipated tax concession for carried interest.

Singapore's new variable capital companies and Hong Kong's partnership funds have garnered considerable interest.

Investors have begun to revisit and "rediscover" alternative structures, notably those offered by the British Virgin Islands, which are more versatile for small to medium-sized funds and for those renminbi fund managers just dipping their toes in the water of the USD fund market for the first time.

Amid all the hype, fund managers have tended to focus on how comparable, or otherwise, these new products are to conventional offshore products, rather than exploring the nuances in terms of what they a...