Why are high net worth investors turning to fund structures?

A fund can be structured flexibly allowing a number of investors to invest in one or more assets and share the returns and the risks of the underlying investments. Typically investors can negotiate their own terms, rather than signing up to a standard form.

There are a number of reasons why a fund arrangement is an attractive way to hold assets. Investors often wish to off load part of a large investment to their associates, so they transfer an asset into a fund in exchange for fund interests and raise monies from third party associates. These monies are frequently used to expand and diversify the assets held within the fund. Alternatively, it may be that entry into an asset class requires a size of investment that can only be achieved by a pool of investors, using a fund structure, rather than a number of individuals. It may well be cheaper for a number of investors to share in the costs of a fund, rather than create their own individual structure to hold the assets directly. Increasingly mangers of alternative assets are offering co-investment opportunities or other “club” type deals to investors, often free of fees or carry, and frequently these investments are made using a fund structure. In addition, once assets are within a fund, the fund interests can be transferred without moving the underlying assets. This can be tax efficient for investors, both in life and on death.

Funds are structured to ensure that the investors are no worse off than if they had invested in the underlying assets directly. Consequently, funds are usually based in jurisdictions which offer a tax exempt company or a fiscally transparent limited partnership. These structures mean that there will be either no, or very little, tax leakage at the fund level. Typically funds are set up in Cayman, Jersey, Guernsey, Luxembourg or Dublin, although US resident investors may invest in US structures. The choice of jurisdiction and vehicle is very often led by the requirements of the potential investors. Holding structures for assets in other jurisdictions may be used in order to take advantage of double tax treaties. Most private equity (including credit funds) or real estate funds, which hold illiquid investments, are closed ended, so the fund has a fixed term life and the investor is tied in until certain events occur.

Usually the fund is operated by a manager, which will be involved with marketing the fund interests and make the buy/sell decisions. Depending on the size of the fund and the number of investors the fund and/or the manager may have to seek prior approval from the regulatory body in the relevant jurisdiction. Most managers will choose to appoint an administrator to run the back office of the fund and keep detailed records of the interests of each investor. It may also be necessary to appoint a custodian or depositary to hold the assets of the fund, as well as a firm of accountants to audit the fund’s financial statements.

Over the last few years a number of innovative private fund structures have been developed. For example, both Jersey and Guernsey now offer “private investment funds” which are quick and easy to establish without too much regulatory intervention. Although the details differ slightly for each island, it is possible, with the assistance of a good administrator, within a couple of days, to establish a fund for professional investors, broadly those putting in over £250,000 each, provided that the fund comprises of no more than 50 investors.

The ZEDRA Funds Team is seeing more high net worth individuals and family offices showing interest in these types of fund structures. They seem to appreciate the simplicity, flexibility and cost savings that these private investment funds can offer.