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Features - July 2013

 

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Investor-centric, cost efficient SMART funds
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Investor-centric, cost efficient SMART funds

New 007 fund model is causing a stir among wealth planners

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The Bahamas Investor Magazine
July 1, 2013
July 1, 2013
Brian Jones

Investment funds are investor-driven products and the demands of different investors are precisely that–different. Clearly, the number one demand of any investor is to preserve and enhance capital and this objective is borne and pursued by the investment manager. However, aside from this a number of important other factors play into the initial viability and ultimate success of an investment fund. Some of these key factors include: service provider quality, proper corporate governance, regulatory clarity and consistency, legal framework and often most critically, operational controls and costs.

Spring & Summer 2013As such, it is no surprise that by a remarkably vast margin, most of the world’s thousands upon thousands of investment funds are domiciled in international financial centers (IFCs). What is perhaps surprising is that some of the top tier lie in the Caribbean region.

This clustering of funds in the colonial isles has come about not simply by coincidence. Nor is it only the warm sunshine and sandy beaches luring fund operators to the region. IFCs such as The Bahamas provide a bona fide tax-neutral platform, together with the necessary professional support and investor-friendly legislative infrastructure that investment funds need in order to operate efficiently and profitably.

Contrary to popular belief, setting up a fund in a tax-neutral IFC is more market access-driven than anything else. Where tax planning plays a role, it is generally not the deciding factor to set up or invest in a fund. Clearly, if an investment is tax-adverse it makes no sense to make that investment. Thus, the best fund structure is one that is tax-neutral, ie one that does not materially impact the taxability of the investor or the fund’s underlying assets.

Given that investment transactions, income, and capital gains are not taxed in The Bahamas, a Bahamas-based fund’s investors are not subject to double taxation at the fund level. Therefore, investors with globally based assets are only taxed in their home countries as appropriate. It is important to note that the ability to operate a tax-neutral investment vehicle is a fundamental facilitator of global investment capital allocation and is critical to creating the flows and liquidity on which financial markets thrive.

SMART funds rising
One product that is attracting many funds to The Bahamas, in particular, is the Specific Mandate Alternative Regulatory Test (SMART) Fund (see graph). This is because there are so many benefits derived from investing via SMART funds, such as regulatory flexibility, operational efficiency, risk management efficiency, transferability and transparency, often at a relatively immaterial cost.

Cost minimization and efficient operations are essential for start-ups and private wealth management funds because setting up a typical hedge fund can often be cost-prohibitive, and inordinate operational costs erode portfolio performance. The lower relative cost base provided for via the streamlined nature of SMART funds is generating what is known as “operational alpha” for private emerging fund managers.

The SMART funds regime is the “outside of the box” response of The Bahamas to such issues. Due to the fact that these funds are a continuing series of industry-driven investment fund models, currently seven in number, with clearly defined parameters, features and legal requirements, SMART funds are serving to demystify the “ins and outs” of investment fund structures.

While maintaining investor confidentiality by statute, SMART funds provide adequate transparency for regulatory purposes, within a streamlined, appropriate and cost-effective structure for suitable investors. On this basis, SMART funds make it more feasible for private individuals and emerging managers to design and operate their own private placement investment funds, while taking advantage of the same benefits hedge funds offer.

SMART funds tend to generate greater investment opportunities than what is offered by more traditional investment vehicles. As such, SMART funds are geared more towards sophisticated and professional investors and are subject to less strict regulations and practically no investment restrictions. This opens greater possibilities for managers to continually develop alternative investment strategies that respond to market dynamics, while actively addressing implications for international investors, from a global perspective.

SMART 007
Making its debut nearly a decade after the launch of the first SMART Fund, the new model 007, also known as the Super Qualified Investor Fund, is the most recent product on the SMART Fund shelf. Industry and market feedback has been positive in response to this new template for structuring a private placement fund that is open to no more than 50 investors.

Some of the features of SMART Fund 007 include private placement distribution to a maximum of 50 investors, with minimum initial investment of $500,000 per investor. SMART Fund 007 also explicitly provides for use as a single investor fund. Similar to the other SMART Fund models, a concise term sheet is utilized in place of the traditional long-form prospectus. In addition, waiver/deferral of the annual audit requirement is allowed, subject to unanimous investor consent.

For local and international asset managers, SMART Fund 007 offers an effective way to create alternative investment products. For qualified investors, it expands their investment universe and raises their investment profile. For the funds industry as a whole, it strikes the optimal balance between delivering bespoke wealth management solutions to sophisticated clientele, while adhering to appropriate regulatory requirements within a risk-based supervisory environment.

Wealth managers, on the other hand, are now making use of the streamlined nature of SMART funds to provide a one-stop-shop approach to wealth management and asset structuring by combining the fund management with succession planning and other wealth management services. Wealth planners are therefore enabled to structure comprehensive wealth planning solutions for their clients, with the aim of managing a sustainable succession planning mandate that gives way to a formal yet flexible approach to multi-generational capital preservation, ease of transferability, and ultimately to the perpetuity of dynastic wealth under the oversight of professional administrators and trustees.

The general advantages of SMART funds are clear, and the applications for SMART Fund 007, in particular, are multifaceted. Therefore, asset managers and wealth management professionals should look into creatively exploring with their legal and tax advisors whether their clients’ international investment demands could be met by using a SMART Fund as their investment vehicle of choice.

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