Financial Times Guide to Investing in Funds

2

The fund

What topics are covered in this chapter?



Investing in a fund



International legal structure of funds



Common forms of funds



Understanding where the money goes



Fund performance

This chapter focuses on the particularities of the fund that is chosen

by a potential investor. The fund is ultimately the only party with

which the investor will have a contract and in this chapter I seek to

break down this relationship to explain not only its relevance but also

its limitations.

Investing in a fund

The fund is a legal entity, the main purpose of which is to allow inves-

tors to put their money into one pot that can grow under the manager’s

control, free of tax. The fund can be formed in various ways, being a

unit trust or a private company for example, or can use the partnership

form. It is rare for alternative strategies to be created as unit trust funds.

In effect, therefore, when you invest in most funds you are simply

becoming a shareholder and for traditional funds possibly a unit holder.

20 2



The fund

Unit trust holders tend to have more limited rights. For shareholders, on

the other hand, their shareholdings can give them rights akin to those

of any other shareholders. Note, however, that when you invest in an

offshore fund you are almost always issued with non-voting shares, thus

ending up with very few rights.

As the name indicates, a non-voting share allows you to take part in

the growth and losses of the fund’s overall capital, but not to vote

on the fund’s affairs. This is what frustrated so many investors fol-

lowing the financial crisis as some funds decided almost arbitrarily

to suspend the production of NAVs, or gated upcoming redemptions

of the funds. There was a strong sense of injustice for many inves-

tors even if these powers had been disclosed in the legal agreements

they had entered into. Investors have sought to argue since then that

those agreements were not sufficiently explained to them but that

has not won them any favours. We shall talk about the impact of

disclosures later in this book. In the meantime it is worth remember-

ing that investors were probably given a false sense of confidence by

those selling the virtues of certain funds, with few investors choosing

to verify the facts.

It is also worth mentioning at this stage that funds in European juris-

dictions, because of different company laws as well as more onerous

regulations, would not be able to exclude shareholders in the way that

some offshore funds did and thus Europe offers a form of implicit pro-

tection. This has meant that more fund business has been driven to

Europe since 2008 and I think this trend is bound to continue. The

new European laws regarding UCITS IV and the AIFMD have both

already contributed to this trend.

The fund and the manager are almost one!



Funds and managers are closely related.



The reason for this is because of the legislation that applies to funds across the

world and which is remote from the public perception that funds are independent.



In principle a fund is only a pooling vehicle. This is akin to a pot of money that

governments recognise as exempt from tax. This is advantageous as only the

ultimate gains made by investors are taxed, thus avoiding double taxation that

would otherwise impact on the growth of the investments.

