Offshore Mutual Funds — What are they and should you invest in them?

In recent decades, Mutual Funds have become increasingly popular among investors. This popularity can be ascribed to the many benefits that they can provide investors. When you add the offshore element to the equation you can start to see why these type of investments have been flourishing in many offshore jurisdictions worldwide. However, like with any investment, there are significant disadvantages too that must be accounted for before making any decisions.

Before proceeding to understand the potential arguments for and against Offshore Mutual Funds, I think it would be advisable to explain the basics about these funds.

Mutual Fund vs. Offshore Mutual Funds
A mutual fund is a type of investment in which numerous investors pool or group their capital together with the objective of investing in a range of assets.Offshore mutual funds are those that are invested in companies outside of the investors’ national borders to increase the returns on the investments.Mutual funds are operated by fund or money managers. The money managers are in charge of investing the pooled capital in the fund to try to increase the value of the investment and income for its investors. The money managers do this by investing in various asset classes such as bonds, stocks, commodities and other money market instruments. One of the main benefits of pooling money in such a fund is that it allows smaller investors access to diversified portfolios that are professionally managed, and that are usually very difficult to create (let alone access) with smaller amounts of capital.

​The investors share any gains or losses proportionally, depending on the initial investment. Mutual funds are also simple investments with lower risks than investing large amounts of capital alone.

Each mutual fund (whether domestic or offshore) has a specific stated objective. The fund’s objective is laid out in the fund’s prospectus, which is the legal document that contains information about the fund, its history, its officers and its performance. Some popular objectives of a mutual fund might include:

• Fund Objective — What the fund will invest in;
• Equity (Growth) — Only in stocks
• Debt (Income) — Only in fixed-income securities
• Money Market (including Gilt) — In short-term money market instruments (including government securities)
• Balanced — Partly in stocks and partly in fixed-income securities, in order to maintain a ‘balance’ in returns and risk.

​​As mentioned previously, investors have started investing their capital in offshore entities mainly to take advantage of lower levels of regulation and more tax-efficient laws, which are prevalent in such financial jurisdictions. Investments in tax haven jurisdictions offer higher rates of return for both parties in a mutual fund, i.e. the fund purchasers and the fund managers. Management companies who oversee these offshore accounts also help their investors by delaying or eliminating taxes on their own profits. The lack of limits, beyond competition, on the fees paid to management companies is another lure for investors.

​Arguments For (Pros) Offshore Mutual Funds
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1. Low Minimum Investment — Offshore mutual funds hold a large attraction to investors looking to make capital gains on smaller investments. Since the pooled capital is allocated between numerous kinds of investments, individual investors are able to legitimately participate in the international money game with much smaller stakes.
2. Diversification — Most financial professionals believe that diversification is one of the best ways to enhance a portfolio’s risk-adjusted return. Thus, offshore mutual funds make it possible for those investors with very little cash to own an undivided interest in a diversified portfolio.
3. Convenience and Accessibility — Nowadays this is perhaps a very important factor for investors when considering offshore mutual funds. Conveniences can include 24-hour phone or Internet access to your account information, check-writing privileges and automatic investment plans that deduct a specified amount each month from the investor’s bank account.
4. Professional Management — Offshore mutual funds provide investors access to professional money managers whose required minimum account size would otherwise put their services out of the reach to the majority of the general investment population.
5. Tax Efficiency — Offshore mutual funds have the benefit of evading taxes, as they cannot be seen as the investment and income of one individual. Usually, the fund is jointly held by investors from different countries so as to avoid being seen as the paper holding company of a single individual. Additionally, investing in offshore tax havens also allows investors to further use capital gains that would otherwise have been highly taxed in their home country.
6. Lower Levels of Regulation — Tax havens have more liberal regulations and policies of secrecy. These relaxed regulations simplify the process of establishing and administering funds, making offshore investments even more attractive. This is also caused by a decrease in regulatory paperwork, which in turn translates to a reduction of operating costs.
7. Economical Reallocation — Most offshore mutual funds are part of much larger fund families, which are a series of funds all issued by the same parent company but with different investment objectives. Most fund families allow their shareholders to switch their money among the various funds within the family with low or no service charges applied. Because of this, offshore mutual fund investors can often reallocate their portfolios at a substantially lower cost than others who invest directly in the underlying securities.
8. Extensive Choice of Funds — With literally hundreds of offshore mutual funds in existence and more being created all the time, it is likely that no matter what investment vehicle, style or approach you prefer, there is an offshore mutual fund that specializes in that sort of investment.

Arguments Against (Cons) Mutual Funds

Despite the many benefits that I have highlighted above, you are recommended to approach any investment in an offshore mutual fund with an awareness of the following shortcomings.

1. High Rate of Management Turnover — Many investors select offshore mutual funds based on their past performance. Unfortunately, management turnover within the asset management industry is relatively high in comparison to other sectors so the managers who were predominantly responsible for a particular fund’s superior performance in the past may no longer be working for that company. Therefore, investors should scrutinize not only an offshore mutual fund’s historical performance, but also who was in charge during that performance and whether the same manager or team is still managing the fund.
2. Safety of Funds — Even though there are increased tax benefits with offshore mutual funds (as highlighted above), there is not always the safety net and protection that is standard when investing in such funds domestically. If you are investing overseas, ensure that you invest in a country with the right regulations, and once again, please seek professional advice in all instances.
3. Deviations in Investment Styles — An investor who wants to preserve a certain asset allocation is completely dependent on the manager of the offshore mutual fund adhering to the fund’s stated investment styles, and that he or she doesn’t deviate in any way whatsoever. Any changes in priorities or investment styles could fundamentally override and destabilise the investor’s asset allocation.
4. Panic Selling — When the market slumps, many investors (generally) tend to panic. Subsequently, these investors will look to sell their offshore mutual fund shares. Since the fund managers must redeem the shares, they have no choice but to sell the underlying securities at a time when there are probably few, if any, buyers. If it were not for the deluge of redemptions, the fund manager would more than likely not sell the underlying securities. Thus, the professional manager’s expertise, judgment and objectives can be disrupted and superseded by the actions of the fund’s investors.

​Risk Disclaimer

Meedah Group and its employees are not a licensed financial advisor. The information presented in this article is an opinion, and is not purported to be fact. Bitcoin and cryptocurrencies are volatile instruments and can move quickly in any direction. Meedah Group and its employees are not responsible for any trading loss incurred by following this advice.

By Mawdud Choudhury, CEO of Meedah Group Limited

Originally published at www.meedah.com.