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Status conscious

Budget changes are making it easier to market offshore funds in the UK.

Investors are to be offered an enlarged range of funds thanks to a change in the taxation of offshore funds in the Budget in March. This is expected to lead to hundreds and possibly thousands more offshore funds to be marketed in the UK.

A number of asset managers, including SG Asset Management, Merrill Lynch Investment Management and Fidelity Investments, have announced plans to start selling funds under the relaxed distributor status regime.

Offshore funds either have distributor status or non-distributor status, which is determined by the Inland Revenue and affects the way they are taxed. To get distributor status, funds must pass tests, including the distribution of 85 per cent of their income to investors. These distributions are taxed at the investor’s rate of income tax.

The growth delivered by distributor-status funds is taxed as capital gains tax, which is why they are more attractive to UK investors than funds with non-distributor status. The gains, as well as the income, of non-distributor status funds are taxed at the investor’s rate of income tax.

In the Budget in March, the Government amended the rules to try to encourage more offshore funds to gain distributor status. The changes were implemented in July. The amendments include the abolition of the rule that every sub-fund and share class within an umbrella structure has to qualify for distributor status so individual funds can qualify.

Investment restrictions on offshore funds gaining distributor status have been scrapped and will no longer have to submit separate annual accounts to the UK, which will reduce costs for the asset manager.

It is argued that the amendments will increase choice for investors and provide access to some top-performing funds that could not previously be marketed here but many IFAs do not believe clients need more choice than the current 2,000 unit trusts.

Tony Stenning, of MLIM, says: “There are around 10 times as many funds sold in Europe than are available in the US. This is partly because of the different tax and regulatory regimes across Europe.”

The change in the distributor status rules, for example, is enabling asset managers to merge small funds that were established specifically for the UK market, with the main funds in Luxemburg. Investors benefit as funds with greater assets under management enjoy lower total expense ratios and increased liquidity.

In January 2005, MLIM is to start marketing a number of Luxemburg-based funds in the UK, including the highly regarded Merrill Lynch US focused value and US value funds. Stenning admits that many IFAs and clients are wary of investing in offshore funds.

“Our job over the next two to three years is to change these perceptions. We need to educate advisers and investors that it does not matter if funds are domiciled in the UK, Luxemburg or Dublin,” he says.

Stenning says another potential significant change is the launch of funds under the new Ucits III regime. The regime has relaxed investment rules for funds in Europe.

For example, the limit has been increased for a fund to invest in another Ucits-compliant fund from 5 to 10 per cent of the portfolio with the option of European regulators to increase it to 20 per cent. Funds will also be able to invest tactically in cash, own property, charge performance fees and adopt an absolute return strategy. Stenning says there is still confusion over certain elements of the taxation of Ucits III, which has limited the number of launches under this regime.

The amendments to the distributor status rules have been welcomed by multi-managers. Gary Potter, co-head of the Credit Suisse Portfolio Service, says it will give them the opportunity to invest in funds that cannot currently be accessed. He says: “There are a number of offshore funds with strong performance that we have come across in our research but we cannot invest in them at the moment.”

Potter says Credit Suisse’s fund of funds generally do not invest in non-distributor status funds because gains are taxed as income on a yearly basis. He and other multi-managers say it is a complex and time-consuming job to calculate the tax for non-distributor status funds separately from the other underlying funds.

IFAs have been less enthusiastic about the prospect of hundreds of more offshore funds being marketed. Alan Steel, managing director of Steel Asset Management, says: “I do not believe we need more funds to choose from. If anything, there is a need for us to have fewer funds. There are plenty of funds available that do not have a good track record of performance.

“There is ample choice of onshore funds with high-quality managers like Anthony Bolton at Fidelity. For the US, where it is said there is a lack of choice, we use UBS, which has consistently outperformed the S&P 500 over the past 18 years and which has been available in the UK for the past two-and-a-half years.”

Mark Dampier, head of research at Hargreaves Lansdown, is also cautious. He says: “There are some good offshore funds, such as HSBC India, which has an outstanding record. Having more funds like this with distributor status would be a good thing.”

He also argues there is no need for more funds as there are plenty to choose from already. But Dampier says one positive development would be to include the performance of onshore and offshore funds in the same tables so it would be easier for investors to compare their performance.

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