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The Side Pocket SMART?Fund

The Side Pocket SMART?Fund

New fund offers investors in Bahamas even more flexibility, ingenious way of removing illiquid assets

The Bahamas Investor Magazine
December 8, 2010
December 8, 2010
David Thain

The SMART Fund programme was designed to provide the industry with a new private wealth management tool with the flexibility to find application within areas not traditionally associated with investment fund administration. The primary facility offered by the SMART Fund concept is an open architecture that allows practitioners to design innovative structures, akin at times to special purpose vehicles, without reference to inflexible regulatory criteria predefined in legislation.

This open architecture always envisaged that increasing understanding and acceptance of the SMART Fund idea would result in an increasing number of SMART Fund models (defined by means of templates) and this has been the case, with six quite distinct templates currently on offer.

SMART new kid on the block
The most recent addition, imaginatively named SMART 006, but more usefully known as the Side Pocket SMART, was designed by Pamela Klonaris of Klonaris & Co and has its genesis in the immediate aftermath of the recent financial crisis. As the hedge fund industry faced a crippling level of investor redemptions coupled with relative illiquidity of some portfolio assets, restrictions on redemptions became commonplace. Terms such as side pockets, gates, and lock-ups, among others, became all too prevalent and resulted in increased administrative inflexibility and a good degree of investor frustration. It was within this climate that The Bahamas SMART Fund provided a facility to offer a tailored, customer-focused alternative.

The Side Pocket SMART is designed to provide fund operators with a simple, inexpensive mechanism to remove illiquid investments from a fund portfolio, whilst respecting fully the rights of current investors and creditors. With 75 per cent approval of the existing shareholders and creditors, the Side Pocket SMART allows the operators of an existing fund (the Parent Fund) to transfer up to 30 per cent of the portfolio into a new Side Pocket SMART, to be held without active management or administration for an unlimited period.

The shares of the new fund are naturally issued to the existing investors of the Parent Fund on a pro rata basis, but are held without the right of redemption. No new subscribers for shares in the Side Pocket SMART are permitted. In this way, the Parent Fund is able to continue operations, including calculation of a dealing price for the purposes of accepting new investors and settling redemptions, without reference to the illiquid assets now held in the Side Pocket SMART.

Shares in the Side Pocket SMART will be issued per the terms of the constitutive documents, but as the class of investor mirrors that of the Parent Fund, the administrative burden associated with the registration of investors would be light. Moreover, as with all SMART Funds, the license may be issued by any local unrestricted fund administrator under an authority delegated by the Securities Commission of The Bahamas and, as such, the establishment formalities can be controlled efficiently.

The original investors in the Parent Fund may redeem shares and receive immediate payment, whilst retaining their investment in the Side Pocket SMART. New investors may buy shares in the Parent Fund without reference to the assets now held in a separate legal structure. When the illiquid assets held in the Side Pocket SMART become liquid or partially liquid, these funds will be returned to the investors or perhaps reinvested in the Parent Fund.

The Side Pocket SMART does not require a fund administrator or a fund manager. No Net Asset Value (NAV) calculations are required and, if all investors agree, the annual audit may be waived. The operators–typically the directors–have certain responsibilities to report to the investors and the Securities Commission of The Bahamas, but these operational tasks are modest. As with all SMART Fund models there is considerable flexibility in the terms to be defined within the Term Sheet, and, as such, irrespective of these basic exemptions, the promoter may define an administrative environment appropriate for the specific Side Pocket SMART.

The SMART choice
Clearly other solutions are available and the use of Special Purpose Vehicles as synthetic side pockets seems to be popular. However, the complexity and cost of these can be intimidating and it is questionable how much understanding of these structures even sophisticated investors really have. In contrast, the Side Pocket SMART offers an inexpensive, simple yet elegant solution. Inexpensive, because the formalities can be organized quickly with limited bureaucracy; simple, because the Side Pocket SMART looks very like the Parent Fund, whilst removing from the administrator an onerous administrative burden; and elegant, because the SMART Fund rules grant extensive flexibility to allow the structure a high degree of customization.

It should be remembered that SMART Fund 006 is merely the most recent addition to the stable of ingenious structures provided by the SMART Fund programme. Each model serves a distinct market segment with a strong focus on private wealth management. Within each class, however, the use and application of the model is limited only by the rules defined within the individual templates. SMART Funds have found application in unexpected ways, such as inheritance planning tools, as ownership vehicles for private equity schemes and as segregated cell companies under Private Trust Companies. And this is merely the tip of the iceberg.

As of June 30, 2010, the number of SMART Funds licensed in The Bahamas stood at 279, a 30 per cent increase over the number licensed at the end of 2009. Indeed the number of SMART Funds has increased every year since the passing of the Investment Funds Act, and this growth is expected to continue.

For more information on SMART Funds please refer to the Investor’s Resources Guide at the back of the magazine or on the website at www.thebahamasinvestor.com, which provides a brief summary of the different models available in The Bahamas.

David Thain
David Thain is the general manager of Arner Bank & Trust (Bahamas) Ltd. Thain holds a Master’s degree from the University of Kent and is an Associate of the Chartered Institute of Bankers. He has worked in the Channel Islands, Grand Cayman and Uruguay, and is also the current chairman of the Association of International Banks and Trust Companies (AIBT).

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