of Messrs Richards Butler, Solicitors and Director, Beaufort Trust Corporation Limited
(From Issue 7,April 1999)
This article responds to a request from the Editor to explain to the generalist trust practitioner reader of the TACT Review what is new, interesting and relevant about OEICs.
Currently, of course, the retail investment scene in Britain comprises the following family of investment vehicles, in ascending order of investor sophistication:
- Insurance related contracts
- Unit trusts
- Investment Trusts
- Segregated discretionary managed portfolios
The unit trust was introduced before the war by M & G. (The “unit trust” was actually invented in England by the Foreign and Colonial Trust in 1868. The collapse of the banking house Overend Gurney in 1886 had sparked an investor revulsion towards limited liability companies, themselves only available since 1855. However, in 1879 came a Court ruling, later overruled, that unit trusts were illegal associations. By the time the decision was overruled, all unit trusts bar one had converted to limited corporate status. The survivor, Submarine Cables’ Trust, came to a natural and profitable end in 1926. M & G’s “invention” in 1931 was based on American models developed before the Wall Street Crash.)
The unit trust began to assume prominence in the late 50’s and early 60’s as vehicles were needed to respond to the need for retail investors to have a clear simple product, net asset value related, transparently administered and easily sold. Within the UK they met this need better than Investment Trusts (puzzles over discounts and premiums to net asset value, the need to use a stock broker, and most importantly, no financial incentive on anyone, after the initial launch, to actively market the investment).
In Continental Europe however, things had taken a different turn with the development of the dedicated investment company, where the investor bought and redeemed shares from the manager/company at or around net asset value. The Dutch company Robeco was an early independent pioneer, although otherwise funds tended to be formed at the behest of and marketed by banks.
Three factors influenced the introduction of the OEICs. First, British investment management skills, already an export at wholesale level, were seen as a potentially valuable producer of revenue from Continental Europe to a retail market.
Next, Brussels had brought out machinery for the, cross border marketing within the EU of investment funds through the UCITS passport explained below.
Third, there was and is considerable incomprehension in Europe to the concept of a trust, on which the unit trust is based, coupling this mystery with some suggestions of disreputable tax evasion. For there to be a British retail investment export, it could not take trust form.
At this point, the British Treasury stepped forward and consulted widely on the introduction of an investment vehicle in corporate form, and OEICs were born. Structurally they are a sub-species of a company with their own regulations and general adaptations of company law. (Open-Ended Investment Companies (Investment Companies with Variable Capital) Regulations 1996.)
That provides the bare bones, but the operational flesh comes from regulations initially introduced by SIB and now administered by FSA. (The Financial Services (Open-Ended Investment Companies) Regulations 1997) These latter regulations mirror extremely closely the regulatory and operational code developed over the last ten years for unit trusts under SIB’s then supervision.
This hybrid provenance accounts for four more features which are much more closely akin to the conventional British unit trust rather than to a company.
Every OEIC has to have a depositary who is to hold legal title to the assets and exercise something of an additional watchdog role, along the lines of the duties of the current unit trust Trustee.
A single manager. Provision is made for OEICs to have a single ‘authorised corporate director’ who will undertake and supervise all of the general business of the company, permanently. This role replicates that of a manager of a unit trust.
Provision is made for OEICs to have a number of investment spokes, operating under different investment mandates – UK growth and income, global bond, US equity, emerging markets, venture capital and so on. Each spoke is accounted for separately. Investors can select one, or a number, and may switch.
- Intra-Spoke Classes
A further refinement is that within any spoke with a particular investment designation, different classes of investment (ie, share capital) can be created to accommodate the differing status or requirements of investors. For non tax paying investors, a ‘gross’ class can be created; classes can be denominated in different currencies; or can distinguish between income and accumulating shares.
What then are the advantages that were perceived for OEICs, and how are these being realised in practice?
The advantages were said to be:
- Euro-comprehensible structure
As explained above, the investor was said to be mystified or put off by the trust/unit trust structure but was quite familiar with the direct buying and redeeming of shares from a company at or around net asset value.
- Retail Promotability.
The OEIC machinery envisages and permits the ACD to charge incoming investors an initial charge (5% or 6% is common), an incentive to promotion that unit trusts have and Investment Trusts lack.
- UCITS’s Passport – Euro~promotability.
The EU UCITS directive (Directive 85/611/EEC) creates a regime under which investment funds of particular characteristics may qualify to receive a `passport` from the body regulating them in their home jurisdiction. Armed with this UCITS passport, the fund and its promoter then have a streamlined application and approval route for marketing in other EU countries. While the marketing of funds across Europe without such passport is less complicated than commentators believe, possession of a UCITS passport clears a number of internal hurdles and also gives an additional layer of comfort to the cross border investor.
- Multi-Spoke, Multi-Class
The operation of a single family of investment options within one corporate body clearly reduces administration and compliance costs, but it also responds to the need of the marketing director to retain funds once they have been captured. According to the marketing man’s dream, the investor should have no reason ever to leave an OEIC except to spend his savings. Each changing investment preference can be accommodated as the investor moves from one sector or class to another. In addition, the regime permits switching fees and these may soon become a useful source of additional revenue.
- Bury Your Dogs
The cynic might point out a further advantage for OEICs to an established operator of retail funds and that is this. A typical UK Trust manager may have accreted through history and acquisitions 8 to 15 different unit trusts. Integrating all of these funds into an OEIC presents the cosmetic possibility of describing certain of the spokes as the successors to the more successful AUTs, and thereby carrying forward, by negotiation with the performance measurers, the track record of the more successful funds. The less successful are thus quietly buried, in this way accounting for the statistician’s phenomenon of “survivor bias”.
London, Dublin or Luxembourg
“Tax comes into everything” as my old senior partner told me on my first day in articles. Those who responded to the Treasury’s consultation on OEICs pointed out that for Britain to have a truly competing European-wide retail product, the OEIC would need to be tax benign in order to compete with similar products available in Luxembourg and Dublin. Industry representations were ignored as regarded income, although the conventional CGT freedom accorded to unit trusts and Investment Trusts extends to OEICs.
While the Treasury stance may now be neutral as to UK dividend income, such is not the case for other income categories and it is abundantly clear that an UK based OEIC is likely to prove unattractive to any tax-shy European investor.
The asset value statistics for equivalent Luxembourg vehicles show that its benign treatment of funds and their income enjoys disproportionate investor support. (Luxembourg had $413 billion of approved funds in September 1998, 17.3% of the total for all EU Countries. Britain only had $250 billion by contrast.)
More recently, of course, the Irish authorities have created an equally helpful tax climate for investment funds managed from Dublin. Dublin costs tend to be lower, and the investor perception of reliability and regulatory rigour appears to favour Dublin over Luxembourg, too. An increasing trend towards the establishment of funds in Dublin is therefore discernible. There must be several hundred Irish VCCs (Variable Capital Companies, analogous to OEICs) and, at the time of writing, only 15 British OEICs (with assets of £14 billion).
Stock Exchange Quotation?
It is an oddity of earliest British unit trusts that while the investor bought units from the manager and could instruct him to redeem them, the funds had a stock exchange quotation as well. There was sufficient “headroom” between the bid and offer prices of the unit trusts for the more nimble jobbers to make a turn, a situation that only disappeared in the 1960s.
However, astonishingly enough, there are advantages of a stock exchange listing even in relation to an open ended or variable capital company where the expectation is that the investor will buy and redeem solely from the manager/ACD. This has nothing to do with a stock exchange listing being necessary to anticipate frantic inter-broker dealings in the units or shares in question, but to accord with the investor’s own domestic regulation or preference.
For example, some wholesale investors are only permitted to invest exclusively in listed instruments (this applies to certain French funds). The fact that they do not intend to use the market mechanism for realising their investment is irrelevant. Equally, there are other investors who have reporting requirements or preferences, and wish to show the lowest possible proportion of “unlisted” holdings.
Dublin has therefore responded to this need for a “phoney” quotation by providing it, and the writer understands that in London one OEIC is exploring similar treatment.
In Britain, OEICs have been adopted in small numbers and, operationally, there is something of a seamless transition from, and reflection of, the unit trust origins. There are stamp duty and tax concessions for integrating unit trusts into new OEICs as well as some marketing and promotion advantages.
Because OEICs were designed to be capable of benefiting from the UCITS passport, the investment restrictions and powers are somewhat restricted. Some major players are, therefore, waiting for the broadening of OEICs and their investment powers which should follow the next consultation round. Meanwhile, OEICs are unlikely to prove an efficient vehicle for attracting to British management skills large quantities of Continental European retail money. These are more likely to follow the path of less tax.
© Keith Wallace April 1999
Keith Wallace heads the Investment and Pension Funds Unit at Richards Butler, Solicitors, advising asset managers and trustees. He is a member of TACT Council.