Having relaxed distributor status rules, the UK has given fund managers the opportunity to easily register their offshore funds for tax-efficient sale in the UK. Three fund groups give their opinions on the impact for investors and advisers
The recent easing of the distribution status rules in the UK will give domestic investors potential access to a universe of funds far bigger than before (see boxout on page 32 for more details). This means that financial advisers to UK investors could eventually have to develop a working knowledge of the top funds in the offshore as well as onshore markets to be sure of giving the best advice.
But not quite yet. The response from international fund groups has not been 100% positive: some have already leapt at the chance to get distributor status, some are in the process of doing so and others have said that, despite the opportunity, they are happy to bide their time and see what comes of the changes.
International Investment asked three fund groups, who fall across all of these categories, to explain what the impact of these changes are, how they affect the fund industry and what financial advisers need to do about it.
International Investment: Could all three of you quickly outline where you are now vis-a-vis getting distributor status on your offshore funds?
Jamie Hammond, sales & marketing director, northern Europe, Franklin Templeton: Where we have a distributing share class we will seek distributor status but we will not be getting distributor status on all of the range. Our Luxembourg Sicav serves European Union distribution and beyond. Some funds have accumulation share classes, some distributor, some both, based on bottom-up demand.
Virtually all the funds have accumulation units and distributor classes have been launched on top of that where there has been demand for them. I would say at the moment, over half of the fund range has distributing share classes.
II: When will the process of applying start?
JH: We will apply at the end of the Sicav's year. This is the first financial year where distributor status could be sought on a fund by fund basis. It used to be done at the umbrella level. We did seek distributor status many years ago but they stopped doing that because of the intricacies of Pan-European distribution.
II: Will your plan eventually be to have a distributor status share class for every fund?
JH: No. We have quite a wide coverage and have expanded the UK Oeic range as well, so where we are looking to set up distributor classes will follow demand - at the moment it is coming more from the discretionary and fund of fund-type market, which has the research capabilities to look wider at both on and offshore funds. At the moment we aren't seeing demand from the intermediary market in a big way and that is because of the sheer choice available in the UK universe - why do they need to look offshore?
II: What have you got in Luxembourg that you haven't got in the UK?
JH: A great deal. We have over 40 funds in the Sicav and eight funds in the Oeic. The Sicav serves Pan-European and beyond distribution for Franklin Templeton and a lot of the funds might have be launched for the Asian market, for instance, and we won't necessarily see demand for that from the UK.
The UK Oeic has the advantage that it lets us link into the Skandia, FundsNetwork and Cofunds. Although I think things will change, in the past you needed a UK fund range for these operational reasons.
Mikkel Bates, head of UK marketing, SG Asset Management: We've had a Luxembourg range of funds, promoted largely from our Paris office, for a number of years. We received authorisation for UK use about two years ago but no one at the time would buy them in the UK because they were all roll-up funds. Unlike the Franklin funds, none of them have had distributing shares because the prime market has been Europe, the Middle East and Japan.
Following the UK budget last year, we selected 12 out of 57 funds initially to apply for distributor status. We now have distributing shares on those funds, two classes on each, for retail and institutional. And although the number of funds with distributing status will increase, it is unlikely to ever be the full range because there are a number of funds which we do not think will have any appeal to UK investors.
The 12 funds we chose we do not have a UK equivalent for, so there is no overlap. If we are talking to a global distributor, then they will pick the offshore fund because that is what they will all have access to.
One of the other minor concerns that investors might have choosing between onshore and offshore funds is currency. The currency denomination of all our offshore funds is the base currency of the assets, which means that investors in our offshore funds will have to buy in dollars or euros. That is not a concern for the top-end discretionary, investment bank-type buyer but for private individuals that may be more of a concern because they have to go out and settle in the base currency with us.
II: What difference will the changes make?
JH: When you are looking at the top end of marketing in the UK - the discretionary managers who are happy to buy both on and offshore, other factors come into play, like the size of a fund. They don't want to own too much of a fund, so when there are two identical ones on and offshore, they might buy the bigger of the two.
When you look at the changes to distributor status - and the fact that you have CGT-able offshore funds, it creates a more level playing field but you still have a difference in terms of administration.
From a distributor status point of view you are going to get a gross distribution, which is something that will have to be declared and income tax paid on it. That could be an advantage for some because it could be used for tax deferral. For UK funds, you get a net distribution that meets your basic rate liability. So for a basic rate taxpayer, there is less administration for the distributor status funds.
Paul Malpas, head of marketing, Nordea Investment Funds in Luxembourg: We do not have any distributor status funds at the moment. We are planning to have some but it will not be this year. The fact is that Nordea does not sell directly in the UK, and if funds go through a wrap of sorts and then distributor status is irrelevant, because the tax treatment is judged on the wrap.
At the moment, as a foreign player without a brand name in the UK, we do not see getting distributor status as particularly interesting. We do not think we will sell a lot of product to the retail market through intermediaries without having a brand awareness.
But the brand by itself is not enough. You need in addition the correct administration, a sales structure, marketing material and so on. Distributor status is great but there are a lot of other issues that come with it.
II: How will that situation change in the medium term?
PM: The business model that intermediaries use is going to have to change to look more like the model used in the US, where brokers are earning commission over years rather then getting a one-off payment up front. I think that it shifts the emphasis away from simply going for a 'safe bet' - a product that you know and are comfortable with - to more performance-related products.
If brokers are getting a performance fee then it is in their interest to select a fund that performs well in the long term. They will then need to shift away from brand to performance.
II: What is driving this change?
PM: Most of the intermediaries in the UK are over 50; the investor is changing as well. I think the baby boomers who are retiring now with some money have a very different profile from the kind who are investing today. They are more demanding, more savvy - especially through the internet, which makes pricing more transparent.
Things are then open for the next generation of intermediaries to set up a long-term business. If money is coming in a pipeline over a period of 10 years, then as an intermediary you have something you can sell when you want to retire.
What does an adviser have to sell a the end of his career - a list of names and telephone numbers? That is no guarantee of future business.
MB: A lot of the UK is moving more towards a trail-fee model: not instead, but on top of the current system.
JH: It's already started to go that way - a lot of brokers now offer their clients a choice. Just look at what the term IFA stands for. Well, they now are starting to be that. The growth in multi-managers is one of the driving forces behind that change. Intermediaries are starting to concentrate on their strengths - tax planning and financial planning. The adviser then appoints a multi-manager. This allows them to make the financial plan and leave the specific investment decisions to someone else.
You need to know how different investments act in certain market cycles and then people can use those as building blocks to create their portfolios. For example, if you look at Abbey's decision to go multi-manager, the clients there are obviously trusting the Abbey brand to find the right investment professionals for their money.
All the research seems to indicate that multi-manager will keep growing in popularity. The concept of that business model is here and it is going to remain.
MB: None of the three of us here have a huge presence in the UK retail market. We rely very much on distributors - the Friends Provident Internationals of this world or the fund supermarkets. We have very little in the way of direct intermediary contact. Our target is very much the upper end of the market, the funds of funds, the investment banks, which will make investment decisions and generally don't make a big issue of brand awareness - they do not have to cope in the same way with the end client's 'comfort factor'. They will generally make the asset allocation decision first then find the funds that suit their investment philosophy of the time.
II: What market segments will be mostly affected by the introduction of distributor status?
PM: Where distributor status is really interesting is through the professional investor. As soon as we have that, we could have five to 10 times the amount of business in this market.
MB: When we received UK authorisation on our funds two years ago - but not distributor status - the UK funds of funds market said to us "Come back when you have distributor status".
II: Is the offshore bond market under threat from the opening up of distributor status, given that one of their unique selling points is that ability to access almost any fund in the world in a tax-efficient way?
JH: No. Offshore bonds are typically chosen for their tax efficiency and they often have some kind of estate-planning element. Bonds are still an non-income producing product and so retain their estate planning benefits. Unless legislation changes regarding the underlying tax benefits, they will still continue to be a good source of distribution for us. Onshore bonds are also a significant product for advisers, even through with-profit bonds and distribution bonds. We have tried to make our funds available through both sides.
II: What about fund supermarkets?
JH: When we looked at how we can increase our UK business, fund supermarkets are generally set up to deal only in UK authorised funds. We are now seeing these sorts of platforms opening up to buying offshore as well as onshore funds. One in particular has said they need a sterling price share class for valuation. One issue for us therefore is whether it is enough just to have a distributing share class in euros or dollars or do we have to add sterling-priced unit.
A further decision we have to make is whether to add sterling-priced share class, or even a sterling-hedged share class, although there is a danger you could end up with a huge umbrella with umpteen different share classes.
MB: The plethora of different share classes is eventually going to affect the TERs of those funds. There is definitely a difference in the TER of an onshore fund and an offshore fund sold into the UK. Our offshore funds have about eight different share classes: retail, institutional, one for HNWIs and so on. All these involve ongoing costs.
II: Speaking of different share classes, one thing offshore funds have been able to do in the past that onshore typically has not is have far more aggressive mandates, including the current hot fad: absolute return funds. With the opening up of the fund universe, is that going to push retail investors to using more unconstrained products?
PM: The risk is that investors do not understand what we are selling them. How do you describe a process that is meant to work in all markets? I imagine that is a very complex task, and then you are on shaky ground because if you cannot explain your own product to someone then you probably shouldn't be selling it.
JH: A few years ago the view was that people gave you money to invest it, so it should be fully invested. You could run a 5% cash position for cashflow but that was it. The recent environment has changed some people's way of thinking. Institutions run their own cash weightings and do not want you to make that decision for them. But if you go to the investor in the street, they cannot pay their bills on relative returns - they want to get consistent, absolute returns. They are saying if you think the market is turning against you, maybe it is not a bad thing if you don't blindly follow it down. By running an overweight cash position it allows you to go into the market at the right time.
So there is a definite interest in absolute return-type strategies. However, that causes other problems - take sector categories, for example. Fund raters want you to be 85% invested in your market segment, otherwise how do you categorise the fund?
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