When investing, you will often see funds listed specifically as offshore funds. Many investors have portfolios of mixed funds in Cyprus with funds often domiciled ‘offshore’.
What are the key differences in terms of legal protection and structure between funds domiciled in, for example, the UK and those listed abroad?
Offshore funds are those domiciled outside of a developed market, which means that they are regulated by the authorities in another country.
This often means there are extra risks involved, as the law and regulations abroad could be different from those here.
Investors could find that legal protections for a fund domiciled in the Cayman Islands are not as tight as they are with a UK based fund, but this really depends on the country in question.
EU regulations designed to create a single market in financial services have ensured that in the countries of the European Economic Area (EEA) – the EU27 plus Norway, Liechtenstein and Iceland – there are common standards of protection for investors, either by the Financial Conduct Authority (FCA) or the equivalent regulator in the other EU countries.
This means that investors can have more assurance about how they will be treated if there is a problem with their fund.
Many offshore funds are domiciled in Luxembourg or Ireland – corporation tax is very low in both countries – and as such are covered by EU regulations.
If you are thinking along these lines, however, you should consider how able and willing you would be to use the law in a foreign country to protect your rights.
What are the advantages of Offshore Funds?
There have traditionally been tax advantages to investing offshore depending on your nationality and country of residence. Laws and regulations change regularly, which makes it essential that you know exactly where you stand if you do invest offshore.
One of the key differences is reporting funds and non-reporting funds. Reporting funds have agreed to keep tax authorities advised on a great deal of information pertaining to their gains and distributions to investors.
As a result, they are treated more leniently in terms of tax. Non-reporting funds have made no such commitment and are treated more harshly. One of the motivations for this is to discourage people using offshore funds to avoid paying all the tax they should. All regulations are subject to change and you must not treat any of this information as advice on how or whether to invest. There are some strategies that are difficult to find onshore, such as hedge funds, or more specialised funds that many professional investors buy in their funds of funds.
However, highly specialised funds are often suitable for few retail investors. Sometimes it is possible to find funds run by fund managers who are well-established in a country that offer slightly different strategies to their onshore equivalents. In other cases, the offshore versions remain open while onshore funds have been soft-closed to discourage new money coming in.
Should I avoid them outright?
There is no doubt that offshore funds are more complicated, meaning you should consider whether you need professional advice before investing in these products.
Many professional investors say that they only use offshore funds when they are looking for an esoteric strategy that they cannot find from onshore funds.
Common sense says that a fund run from Ireland by a well-known fund house with a large presence in the UK is an entirely different animal from a hedge fund run from a tiny island in the Caribbean that you cannot place on a map.
Offshore funds can provide excellent diversification but as always do you due diligence before making any investment decisions and seek advice where appropriate.
By Andrew Lumley-Holmes
The writer is Cyprus Country Manager at Chase Buchanan andrew.holmes@chasebuchanan com