Offshore funds offer wider opportunities
14th July 2011 09:50
by Cherry Reynard from interactive investor
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As if fund selection were not complicated enough, in April last year the Investment Management Association (IMA) decided to include offshore funds in its sectors.
At the time, this brought a further 91 funds into the comparison tables. More have been added since and more are pending admission. Although steps have been taken to level the playing field between onshore and offshore funds, there are still disadvantages for UK investors using offshore funds.
The question for investors, therefore, is whether the investment case stacks up sufficiently well to compensate.
The key reason for asset managers to launch funds in the main offshore jurisdictions of Dublin and Luxembourg is that they can market their funds across Europe without going through the regulatory hoops of launching in each individual country. This is fine for providers but has no discernable advantage for the end investor and brings certain complexities.
In terms of tax, the key consideration for investors is that a fund has 'reporting status'. This concept was introduced along with a new tax regime for offshore funds in December 2009. Reporting funds have agreed to meet certain reporting requirements with HM Revenue & Customs and, as such, attract favourable tax treatment. The majority of offshore funds available to UK investors will fall into this category.
But this is not the only potential wrinkle: many offshore funds will not pay tax at source on dividends. This allows for 'gross roll-up', which can be an advantage or a disadvantage.
On the one hand, it defers the tax payment and allows for stronger compounding of returns. On the other it can be an issue for those who would not otherwise have had to fill out a tax return.
Equally, offshore funds are not automatically part of the Financial Services Compensation Scheme. If funds are recommended by an FSA-regulated firm, they should be covered by the scheme, but may not be if bought direct.
They will, however, be covered by equivalent schemes in the major offshore jurisdictions such as Dublin and Luxembourg.
Having said all that, the difficulties should not be overstated.
Alex Barry, head of asset management sales at JPMorgan Asset Management, points out that offshore funds can be placed into ISA wrappers and are now available through a number of fund platforms. Nevertheless, the complexities mean the investment case for offshore funds has to be that much stronger.
Perhaps the most important reason to consider offshore funds is that they can provide access to strategies or fund managers not available elsewhere. Barry says the main selling point for offshore is the sheer breadth of funds: "Offshore funds have to have appeal in a multitude of different countries and, as such, investors have more choice. There may be niche funds, investing in Thailand or Singapore for example, that are simply not available in the UK-authorised market."
Nick Smith, a director of Allianz Global Investors Europe, says that from a fund group's perspective there may not be enough demand in an individual country to support a domestic listing, but if a fund can be marketed across Europe and demand aggregated, it becomes cost-effective. He believes it can also act to keep total expense ratios lower in more niche strategies.
Because offshore funds have been designed to appeal to an international audience, they tend to be focused on certain types of asset class - notably bonds, international equities and hedge funds. There is little point listing a UK equity fund offshore when the majority of buyers will be UK investors.
Indeed, there is only one offshore fund in the UK all companies sector and one in the UK equity income sector. The highest concentration of offshore funds is in the specialist sector, which accounts for 50 out of the 194 funds listed.
Robin McDonald, co-manager of the Cazenove multi-manager range, points out that most of the funds in the alternatives space are listed offshore. He holds a number of hedge funds - Eclectica, Nevsky and Majedie Tortoise - that are listed offshore and whose strategies, he says, are simply not available onshore. The same is true for a number of the more esoteric bond strategies he holds.
That also applies for a number of fund management groups, particularly those coming from the US. Barry says: "If you are a US fund management group and are faced with the choice of setting up one fund in Dublin or Luxembourg, or setting up lots of funds in individual countries, you will tend to go down the one fund route and sell it across Europe."
This means that skilled fund managers such as the team at Findlay Park, which manages specialist North American smaller companies funds, are only available offshore.
Gavin Haynes, investment director at Whitechurch Securities, says: "The only time we look for offshore funds is when we want an esoteric area and there isn't availability onshore. A client might want a Vietnamese fund, for example, for an aggressive portfolio. Alternatively, a fund manager might be head and shoulders above the rest of the market in their area. This is true for Findlay Park."
There is no currency risk, unless investors want to take it. Most funds have dollar, sterling and euro share classes, so investors can use their home currency to invest. Offshore funds can also be used to take positions on different currencies if necessary.
McDonald says: "We have the Aegon offshore Strategic Bond fund. The group does have an onshore fund, but we wanted to own it in US dollars because we believe the dollar will be relatively attractive over the next few months."
That said, offshore funds do not tend to be a natural choice for non-professional investors. Smith says this is starting to broaden out as offshore funds appear on more platforms, but many investors prefer the security of the UK where, after all, there is still considerable choice.
The inclusion of offshore funds in the IMA sectors has brought some new strategies to UK investors, which allow for a more nuanced and diversified portfolio. However, they are unlikely to offer much to supplement an investor's bread-and-butter portfolio where there is sufficient choice in UK-authorised funds and it is unlikely that offshore funds would bring something new.
Offshore funds: A route to more esoteric plays
This Dublin-listed fund is just $17.3 million in size. It was launched in March 2010 to invest in the Middle East and North African equity markets, which, the group believes, is a strong long-term investment story, demonstrating high economic growth, favourable demographics and high infrastructure spending.
The fund is managed by Ghadir Abu Leil-Cooper, Baring's head of EMEA. It has a total expense ratio of 2.3%, reflecting the illiquidity of frontier markets and the relative expense of moving in and out of positions. It has marginally underperformed its benchmark - the MSCI Arabian Markets ex Saudi Arabia Total Net Return index - since launch.
This is an example of a strategy that is difficult to find in an onshore fund. The Investec GSF Managed Currency fund is a multi-currency mutual fund, designed to help investors protect the purchasing power of their assets through the management and diversification of currency exposure.
It has both quantitative and qualitative parts to the portfolio. The quantitative process will follow factors such as momentum or valuation, while the qualitative part of the portfolio will take strategic positions on, for example, the performance of the euro.
This fund has historically been a strong performer, beating the MSCI World index from 2000 to 2008. It has struggled in recent markets, however, as its focus on high-quality, defensive assets has hit relative performance.
The fund is managed by Taube Hodson Stonex Partners and prioritises quality companies on reasonable valuations, irrespective of their MSCI World index weighting. It is constructed bottom-up and takes a thematic, rather than sector or country, approach. Most stock analysis is done in-house and broker input is limited. Instead the team value meeting the management. It is AAA-rated by S&P.
Janus Capital is a strong US house, but it has no UK-authorised funds and this concentrated US portfolio is only available offshore. It is a top performer, beating its Russell 1000 benchmark over one, three and five years. Capitalised at $1.28 billion (£790 million) it has an annualised five-year return of 6.02%.
Its investment process is opportunistic, aiming to pick the best 30 to 50 shares in the US market, regardless of size or benchmark weighting, identifying companies creating value through margin improvement.
This article was taken from the July 2011 issue of Money Observer.