What it means
A mutual fund collects money from investors and invests it according to a stated plan. When the fund is established in another country, such as Luxembourg, Ireland or the Cayman Islands, it is called an offshore fund.
These centres have built strong fund industries through clear laws, experienced service providers and tax rules that avoid taxing the fund itself. Offshore funds often sell to investors in many countries.
In Europe, many are structured as UCITS, a set of rules which allows a fund approved in one member country to be sold across the region. This gives investors a broad choice of funds and gives managers a larger market.
The potential benefits include access to markets and strategies that are not available at home, the ability to hold the fund in major currencies and in some cases lower tax at fund level. Some investors, such as expatriates who live abroad, find them convenient.
Fees and minimum investments, however, can be higher than for local funds. There are also important cautions.
Tax treatment depends on the investor's home country, and some countries tax foreign funds in a harsher way. For example, US taxpayers who hold many non-US funds face complex rules and reporting, so a fund that looks attractive on paper may be a poor choice after tax.
Before investing, a manager or individual should check who regulates the fund, who holds the assets as custodian, how the fund values its holdings and what the full costs are. Funds approved under well-known regimes with independent custodians and auditors are generally safer than lightly supervised ones.
It is also wise to take tax advice in the investor's own country, before the money is invested and not after.
In practice
Real-world examples.
Example
An expatriate engineer working in the Gulf region invests $60,000 in an offshore fund that holds global shares. The fund is based in Luxembourg and reports in dollars. He avoids converting his savings into a local currency, and he can keep the investment if he later moves to another country.
Example
A family business holding $2,000,000 of surplus cash buys units in an Irish-domiciled bond fund. The fund spreads the money across hundreds of bonds in several currencies. The finance director reviews the fund's fees and rating every year.
Example
An investor in a country with strict tax rules on foreign funds finds that her return is reduced by a higher rate of tax and heavy reporting. Her adviser shows that a local fund with a similar strategy would leave her better off. She switches the money after taking tax advice.
Formula
Calculation
Net gain = amount invested x (gross return - total expense ratio)
An investor puts $100,000 into an offshore fund that earns a gross return of 8% in a year. The fund charges a total expense ratio of 1.5%, covering management and other fees. Net gain = 100,000 x (0.08 - 0.015) = 100,000 x 0.065 = $6,500. Taxes in the investor's home country would reduce this further.Case study
Seen in the real world.
Harborview Wealth is a fictional adviser used to illustrate offshore mutual funds. In this illustrative story, a client with $500,000 asked to move her savings into a well-known offshore fund because a friend had earned high returns. The adviser compared three similar funds, one offshore and two local.
The offshore fund had a total expense ratio of 2.0%, compared with 1.0% for a local fund holding almost the same assets. On $500,000 the difference was 500,000 x 0.01 = $5,000 a year before tax. The adviser also found that the client's home tax rules would treat the offshore fund less favourably.
The client chose a local fund and used part of the savings to buy a low-cost global fund. The adviser noted that offshore funds suit some investors well, but cost, tax and regulation should be compared before deciding.
Watch out
Common mistakes.
- Assuming an offshore fund avoids tax. Investors are generally taxed on gains in their home country, and some regimes tax foreign funds more heavily.
- Ignoring fees. Offshore funds can have higher costs and these reduce returns every year.
- Skipping due diligence on the regulator and custodian. Weak oversight raises the risk of fraud or poor handling of investors' assets.
Questions
People also ask.
Are offshore mutual funds legal?
Yes, they are legal where properly regulated, but investors must report them and pay tax in line with their own country's rules.
What is a UCITS fund?
It is a type of European fund structure with strict rules on investments and investor protection, which can be sold across many countries.
Who holds the fund's assets?
An independent custodian, usually a bank, holds the assets for the fund, which adds a layer of protection.
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