By wrapping fund choices in an offshore life bond, investors can bypass many tax disincentives and still obtain access to a diversity of products available offshore
It is one of those great popular misconceptions that the UK is a land where free speech is held up as one of our greatest civil rights. In fact, oppressive UK libel laws considerably restrict what can and cannot be said under the banner of free speech.
This is doubly so in financial services, as the Conduct of Business and Advertising rules can turn a simple statement into a mass of contradictions, legal jargon and meaningless statutory phrases. (You have no idea how much I had to use the expression freedom of speech to get the above paragraph through my compliance officer).
Similarly, in many ways, the UK regulatory regime should more accurately be known as investment limited.
There are a remarkable number of restrictions on the rights and powers of fund managers in the UK. By breaking with the rules of the game as defined by the UK authorities, fund managers can end up with significant tax penalties or without the ability to market and sell their portfolio in the UK.
These restrictions range from rules on diversification, shorting stocks, the prudential use of derivatives and custody, through to reporting and disclosure. The latter elements surrounding the provision of information is something few would ever want to see unregulated or unsupervised, especially after Enron.
But the rules in the UK are not restrictions which have been implemented by some draconian regulator. These are rules, developed over the ages by generations of experience of the problems which can affect investment, that are too clever by half. Their aim is to protect the public from investment going horribly wrong, or them losing vast sums of their capital.
Of course, any set of rules based on past experience can rapidly become out of date and either fail to protect consumers because they are not up to date with modern investment techniques, or end up restricting some forms of investment that could actually protect the public (which is arguably the case with some aspects of the prudential guidance notes on the use of derivatives).
But what is rather interesting is that there is another game in town, a game with a completely different set of rules that could be characterised as investment unlimited and it is to be found in offshore funds located within offshore portfolio bonds.
Offshore portfolio bonds allow investors access to a far wider range of investment funds, often without restriction, and certainly with fewer restrictions than in the UK.
If variety is the spice of life, then offshore bonds represent a veritable feast of investment flavours and cocktails that are often limited only by the imagination of fund managers.
Offshore investors can also access funds that are truly active. Many so-called actively managed UK funds are nothing more than closet trackers, and this is a direct consequence of regulation and commercial pressure.
In contrast, truly talented and really active fund managers do exist (offshore) often, but not exclusively, at the helm of hedge funds.
Furthermore, offshore funds offer investors the ability to access more esoteric funds that are based on more imaginative financial arrangements than can be found onshore. Some of these are clearly gimmicks, others downright dangerous in the actual risk profile, but many are intelligent attempts to extract value from financial relationships where small but profitable opportunities exist. A consequence of the UK regulations is that the restricted universe of funds on offer all face in one direction. In a bull market, they will go up, in a bear down and in a crab market sideways.
Offshore funds have no such limitations. There are funds that take blessings from bear markets and grow as the markets fall, others that profit from a flat or stable market and some that are completely uncorrelated with the market movement.
Over the past two decades, we enjoyed a long and strong bull market that made many feel that the stock market was a long-term escalator. This situation obviously favoured the restricted long-only UK fund range as it could not help but rise with the market.
Unfortunately, any investor in the UK who attempts to access offshore funds directly is penalised by tax restrictions designed to keep them onshore. Investors are subject to income tax (not capital gains tax) when they switch or surrender their investment choice. This is unattractive to many investors because there is little benefit in this choice if you are penalised every time you change your mind.
Furthermore, proposed changes to the taxation of certain offshore funds mean that investors may suffer annual tax charges if they invest in some funds direct. But by wrapping their fund choice in an offshore life bond investors can bypass many of these tax disincentives and still avail themselves of the real choice and diversity these funds can provide.
Within an offshore life bond, investors are entitled to the gross roll-up offshore funds can supply, which, over the longer term, can provide valuable tax advantages over onshore funds. And as a non-income producing asset, there is no annual tax to pay on the funds, irrespective of the outcome of the proposed reforms of offshore fund taxation.
Far more importantly, investors can switch and transfer their investment across the full universe of the offshore without any worries about creating a tax event. This means that investors can create a dynamic portfolio of funds that can be spiced with an exotic and constantly changing cocktail of funds without any worries about tax charges or penalties.
However, there are funds out there that are frankly nothing short of scams. That is why I cringe every time I see a product provider trying to sell hedge funds in the retail off-the-page investment market. Of course, advice is not the only solution and it cannot guarantee that clients will not understand these different funds.
Some offshore providers take this protection a step further for investors. As well as allowing access to virtually the entire fund universe they offer investors comprehensive protection on their portfolios, such that in the event of death, the investor's portfolio will be at least 101% of their initial investment, or a greater protected amount if the fund value has increased at a half-yearly review date.
While such protection, and the insistence on quality of advice, alone cannot guarantee that investors will not become unsatisfied or concerned with their investment, neither can regulation ' as financial scandals in the UK have demonstrated.
Offshore investment is a tool that, when used correctly and wisely can ensure a client's portfolios are well diversified and tailored exactly to their needs.
Neil Lovatt is director of marketing at Scottish Life International.
Our weekly heads-up for advisers
'Nothing can prevent scammers developing workarounds'
Stalwart Scottish Mortgage takes third place
Consistency and compliance vs. slower reaction time
Search for replacement to begin imminently