“The expansion of choice has become an explosion of choice, and while there is something beautiful and immensely satisfying about having all of this variety at our fingertips, we also find ourselves beset by it....But can we really complain?”
From The Art of Choosing by Sheena Iyengar,
Professor, Columbia University School of Business
Professor Iyengar is, of course, right: In life—and in financial services—choice abounds. The June 15th funds seminar in Zürich illustrated the wealth of business choices available when structuring funds. The topic was private equity/alternative investment funds in particular, and the speakers hailed from Bank of Luxembourg, Ernst & Young, Loyens & Loeff, and United Trust.
Commendably, no one who attended the seminar chose to complain about their choices.
On the contrary, the audience listened gamely as the list of questions multiplied. Namely: What are among the “best” strategies for setting up private equity funds? How does one gauge the risk level of the investment? How do various jurisdictions accommodate this specialised fund administration?
These are the decisions considered in this paper. We will also look at the implied meta question: When it comes to setting up and administering funds, does the abundance of choice help or inhibit decision-making?
Our point of reference for this inquiry is the Zürich presentation on private equity funds in which United Trust recently took part.
Waves of Possibilities
The operative question: what are the best strategies for setting up efficient alternative investment funds?
Let’s focus first on what “efficient” means. On this, we have consensus. Fund managers, investors, advisors—all of us want the fund to be secure. We want it to be liquid. And, of course, we want return on investment.
The questions then arise: How secure must the fund be? How liquid? And how much return on investment do we expect? Enter the choice conundrum
It was Ernst & Young’s Koenraad de Witte who referred to these and other choices as “waves of possibilities.” Consider some of the variables. We have the choice of fund type (real estate, hedge fund, for example). The choice of financial instrument (i.e. the SIF or QIF, SICAR or SOPARFI). The choice of jurisdiction. The choice of financial service providers (i.e. domiciliation agent, central administration agent, custodian).
That’s a lot of choices. In this sea of options, what guides fund set-up strategy?
Paramount are three related variables: the risk level and related financial instrument; the jurisdiction; and the calibre of expertise—in setting up, running, and administering the fund.
Setting up Funds:
The Role Risk Plays
To illustrate the choices around risk, Mr. de Witte used real estate as an example. He outlined the four dominant real estate strategies: Core, Core-plus, Opportunistic, and Development. He then assigned each strategy an accompanying risk profile. This was the first step in showing how risk level contributes to selecting the fund’s structure.
An example: a fully-occupied building with a 27-year lease and a 5% projected yield. It sounds Core. It sounds quite safe. But there’s evidence to the contrary: the building is located in a “high-risk” country.
The question: Could this particular project, with this particular risk profile, qualify for structuring as a Luxembourg SICAR—the Investment Company in Risk Capital? The SICAR could be of great benefit because it’s tax-efficient; securely regulated; and earmarked for risk-capital investments.
Interestingly, the property in question does not qualify for structuring as a SICAR. The reason: the fact of being in a high-risk country doesn’t qualify the project as involving risk capital. The strategy is characterized as “buy-and-hold”; work done on the building is minimal and does not engender risk. And so the project fails to meet the SICAR’s risk criteria.
Contrast this with a property in the Development category. Here, the intention is to add value. And that means, for example, a full renovation, renegotiated contracts, renewed tenants—and the considerable risk that entails. This project does meet the SICAR’s risk profile.
In both cases, the project’s risk level determines how the fund is structured.
Where to Domicile?
The ability to gauge risk professionally also comes into play when choosing the fund’s preferred jurisdiction.
Here, the initial choice happens to be only binary: whether to locate funds onshore or offshore. The historic debates on this subject truly are mythic: they involve politics, economics, business, and ethics. Currently, though, onshore is the trend. In June of this year, a survey of alternative investment funds revealed that 24 per cent of managers have shifted offshore funds onshore. An additional 27 per cent of managers reported that they are considering the move. The survey was conducted by KPMG and RBC Dexia Investor Services.
Increased regulation is a main motivator for onshoring. The European Union’s Alternative Investment Fund Managers Directive (AIFMD), adopted on May 27th of this year, is just one example of the post-crisis regulation coming in to play. The official start date for this directive is 2013, though some jurisdictions are already modifying their local fund practices.
Once the onshore/offshore issue is resolved, the quest for the right jurisdiction remains.
United Trust’s Position
Of these decisions, choosing a jurisdiction is among the most vital. We have pronounced views on where to set up funds—and on how to make that call.
Namely, we think choosing a fund jurisdiction is much more than a quantitative decision. For United Trust, it’s not just about knowing tax rates; the number of billions of assets under custody; or the head count of a jurisdiction’s financial workforce.
Often, we see qualitative information as pointing toward one jurisdiction rather than another. For example, at the Zurich seminar, United Trust fund administrator Sinan Sar covered off on all the relevant figures supporting Luxembourg. He cited the 20 per cent of the country’s work force that services the financial industry. And he identified Luxembourg as the world’s largest domicile for cross-border funds.
Fair enough. But the qualitative information Mr. Sar conveyed is, we think, just as convincing. United Trust does extensive fund business in Luxembourg because, as Sinan noted, “The government is extremely close to the industry.” There are committees and think-tanks in place around various financial instruments, including the SICAR. Luxembourg has consistently been among the first countries to implement new regulation at the local level.
And to codify our business commitment to Luxembourg, United Trust sought and earned SAS 70 certification. This is “a widely recognized auditing standard developed by the American Institute of Certified Public Accountants.”
All of this qualitative info testifies to the stability of the jurisdiction—and to United’s business there.
Choosing Financial Services
So: choice of a fund set-up strategy. A binary choice of onshore versus offshore—and of particular jurisdiction. Choice of financial instrument. Choice of risk level. Choice of service provider.
Does this abundance of options help—or inhibit—when setting up funds?
Professor Iyengar’s research may suggest an answer. “There are times,” she has explained, “when the presence of more choices can make us choose things that are not good for us. For me the clearest example is that the more retirement fund options a person has, the less likely they are to save for their old age….That’s where it becomes clear that [too much choice] can actually be detrimental.”
Fortunately, fund professionals are a far cry from those who buy (or don’t buy) retail financial products. People in the fund industry are largely sophisticated. They are less prone to be paralysed by too much choice, more likely to be proactive.
And yet we acknowledge the truth of Professor Iyengar’s findings: that having a great many options does make decision-making more complex.
At the end of the day, fund professionals need all these choices for financial and fiscal mobility. United Trust’s task is to make these choices lucid and transparent—and then to carry out administration. This is how we help everyone from fund initiators to advisors flourish.
