Funds in the sun

Saturday, 01 March 2014
Jerome Dwight explains why Latin American families intent on diversifying their holdings outside of their home countries are looking to the Caribbean for solutions.

Economic growth and unprecedented wealth accumulation in Latin America (LATAM) mean growing numbers of high-net-worth individuals (HNWIs) are turning their attention to the way in which they preserve and enhance their wealth. As significant wealth accrues, investments in family portfolios have become far more sophisticated, with hedge funds, private equity and investments in operating companies becoming mainstream. With this increased complexity of holdings, it should come as no surprise that high up on the list of needs for most LATAM HNWIs is a vehicle or structure that can manage and support a diverse range of asset types. One umbrella legal structure that is capturing the attention of advisors and clients alike is the private family fund (PFF).

Multiple purposes, multiple benefits

The PFF is a mutual fund structure originating in the institutional arena that has now been adapted for use by wealthy families as a tailored vehicle to hold diverse assets, ranging from portfolio investments, interests in operating companies, real property, hedge funds and private equity holdings. Essentially, these funds are best described as mutual funds with customisable features available for families or closely held groups of related parties. PFFs allow high-net-worth families to aggregate their worldwide assets and receive a simple unit value of their holdings from an independent administrator, which is useful in monitoring the overall assets and avoiding potential conflicts among family members. The variety and breadth of PFFs continues to expand, with many jurisdictions across Europe and the Americas offering a unique flavour of these ‘regulated structured funds’. One region where there has been a significant increase in their use is the Caribbean, where Cayman Islands funds and Bahamas Specific Mandate Alternative Regulatory Test (SMART) funds are fast becoming the PFF vehicles of choice for many high-net-worth LATAM families.

PFFs offer a multitude of benefits, ranging from the consolidation of diverse and complex investments, and cost efficiencies achieved by the pooling of assets, to the delivery of independent net asset valuations. The availability of an internationally recognised registration system in the Cayman Islands and Bahamas also offers enhanced substance when investors are dealing with domestic authorities. Further, PFFs provide potential tax benefits to families, depending on the laws of their home countries. For example, in certain LATAM countries, redemptions of holdings in registered funds such as a Cayman Islands fund or a Bahamas SMART fund may achieve lower tax treatment in a family’s home country compared to other methods of distribution. Other attractive features of PFFs include the level of privacy they offer. Unlike in many LATAM countries, where investments and investor details are routinely published, there are minimal public reporting requirements in respect of underlying holdings held in Cayman and Bahamas registered funds. In a succession-planning context, certain forced heirship rules can also be mitigated by holding assets within a PFF.

PFFs in practice: a LATAM example

A large LATAM family owned, through their individual holding companies, a conglomerate that had been in the family for generations. As the business grew in complexity, made foreign investments, developed global treasury capabilities and generated significant dividends, there was growing uncertainty within the family about the value of the overall asset base and members’ individual interest. Additional challenges emerged, as there were no clear guidelines as to how they would exit individual investments.

The solution proposed by the advisors was an offshore private fund to hold many of the conglomerate’s diverse international assets, including business ventures, multiple investment portfolios, insurance assets, inter-group commercial paper and international real property. An independent fund administrator was appointed to provide the fund’s unit holders with transparent and clear monthly reporting in the form of net asset values on a combined basis, as well as on each individual share class.

All of the fund’s assets were designed to be administered and held by an independent fund custodian and investment manager acting under clearly defined fund guidelines. In this format, the structure reduced the potential for conflict among family members, consolidated the assets under a recognised legal structure and provided for clearly defined entry and exit mechanisms. Over time, it was expected that further assets within the family or the business would be contributed into the fund, along with additional investor participants in the form of younger generations of family members being granted existing or new units of the fund.

Enhanced strategies for LATAM PFFs

In situations where family members wish to have part of their wealth in local onshore investment portfolios and the remainder offshore, planners are able to use an ‘onshore feeder’ fund that invests offshore in a Cayman Islands (or comparable) master fund. This enables both funds to be managed under a single strategy, benefiting from access to onshore and offshore investment opportunities, consolidated net asset value reporting, potential tax minimisation and cost savings from the pooling of assets under a single structure. Side-by-side structures may also be established, where, for example, a Cayman Islands investment fund and an onshore fund invest in parallel in complementary or negatively correlated investment strategies to maximise overall portfolio return. These strategies can be particularly helpful in managing the overall costs of administration associated with complex fund assets requiring various foreign exchange, trade execution, custody and settlement functions.

Despite the growing number of measurable benefits of PFFs, advisors should, however, remain cognisant that the success of a strategy still hinges on similar factors as apply to trusts, such as the expertise of the administrator, the family’s domicile, the law of the fund’s situs, the success of investment managers and the safety of its global custodian.

Cayman Islands funds

The Cayman Islands is one of the world’s foremost fund jurisdictions. An investment fund, as provided for under the provisions of the Cayman Islands Mutual Funds Law, may be established as an exempted company (including a segregated portfolio company (SPC)), a unit trust or a limited partnership. The exempted company is the entity most often used for the establishment of family fund vehicles. The various types of Cayman funds enable structuring solutions to suit different types of objectives and needs.

A unique aspect of the SPC under Cayman mutual funds legislation is that it allows various family members to use a single legal vehicle to benefit from the pooling of assets, while allowing for segregation of individuals’ assets and liabilities. This protects each individual’s assets from the liabilities of others – for example, if one member wishes to adopt more risky investment strategies than the group’s other members. This is in contrast to many LATAM countries, such as Brazil, where funds are single-class style, with collective ownership of assets and unlimited liability applicable to investors. The use of such ‘protected cell’ companies can also offer flexibility in situations where one wishes to limit the recourse of creditors in one share class by ring-fencing the assets attributable to other share classes.

Bahamas SMART funds

The use of Bahamas SMART funds has grown in excess of 40 per cent to 50 per cent over the past three years, with the majority of funds consisting of ten or fewer related members originating predominantly from LATAM. Building on its long history of providing investment fund services, the Bahamas enacted the SMART fund regime in 2003 specifically to address the increasing demands of high-net-worth LATAM families.

The Bahamas SMART fund allows families to employ a wide variety of collective investment structures under six distinct models, varying by type of asset class, level of regulation and number of investors. In fact, when investment portfolios include a heavy allocation of non-traditional asset classes, such as structured notes, private placements, hedge instruments and private equity, certain Bahamas SMART fund models provide for a higher level of flexibility in respect of the manner in which such investments are held, measured and reported on, including the waiver of external audit.

Why the Caribbean?

LATAM families are intent on diversifying their holdings outside of their home countries, and so it comes as no surprise that the volume of foreign fund formations in the Caribbean has seen a steady increase. Governments and service providers in the region have welcomed these developments by enacting their own version of flexible legislation that allows for families to use a single structured vehicle for the pooling of assets and family holdings. On the heels of the success of the Cayman Islands and Bahamas SMART funds, Barbados is also poised to enact much-anticipated legislation for private trust companies and a new Mutual Funds Act incorporating hedge fund provisions.

Several factors driving LATAM families to use Caribbean PFFs have been observed, including, to name a few, a lack of local fund providers with capabilities to handle complex portfolios, limited access to global investment offerings, onerous central bank reporting demands and tax regimes that make it disadvantageous to hold direct foreign assets. The lack of choice is no more evident than in the limited array of local investment choices available. For example, in Brazil, the BOVESPA exchange offers only roughly 400 listed securities to affluent investors. This supply-demand disparity continues to pose challenges for LATAM families.

Along with flexibility to hold diverse investments, receive independent net asset valuations, and benefit from tax and cost savings, PFFs offer planners a single regulated vehicle that aims to maintain trust and confidence among family members and, equally as important, in their advisors. Combined with the Caribbean’s close proximity and similar time zone to LATAM, mature fund legislation, robust banking and legal systems, and reputation for excellence in the provision of financial services, it’s not surprising that LATAM HNWIs are looking more closely at Caribbean PFFs.

Author block
Jerome Dwight

Jerome Dwight explains why Latin American families intent on diversifying their holdings outside of their home countries are looking to the Caribbean for solutions.

The content displayed here is subject to our disclaimer. Read more