Family investment funds – the benefits of UK authorised fund structures

Hello, everyone, and thank you for joining us today on “Family Investment Funds and the Benefit of UK Authorized Fund Structures.” I’ll pass it over to my colleague, Neil Coxhead. Over to you, Neil.

Thanks, Ellie. And a warm welcome to our latest Waystone webinar, which will focus on the benefits of authorized UK fund structures for families. This webinar has been specifically designed for wealth managers and family offices who wish to explore the use of closely-held investment funds for families and their associates. I’m joined today by three subject matter experts. Firstly, Peter Ball, a tax partner at Bishop Fleming. Peter specializes in advising families who are seeking guidance on how to arrange their personal affairs in the most effective way. Peter works with high-profile entrepreneurs and families with complex multi-generational planning needs both in the UK and overseas.

Secondly, Lora Froud, a partner of Macfarlanes. Lora advises clients on structuring of regulated fund vehicles that allow wealth managers to build bespoke global portfolios personalized for families that will allow a legacy to be created and passed down through the generations. And last but by no means least, Rob Callander, my colleague here at Waystone. Rob works within our Authorized Corporate Director, ACD Business, and has launched a significant number of investment funds structures for families over the past decade. Rob has worked with a number of private clients, family offices and wealth managers as well as sitting as an advisor within established family councils.

Benefits of Authorized UK Fund Structures for Families

So, during the course of our conversation, we’ll be taking a deep dive into the benefits of authorized UK funds structures for families, including investment options and structuring, tax profiling of family investment funds, creation of single-family council, and the role of the ACD and the importance of the assessment of value reporting for families. So, without further ado, and to start things off, Lora, can I ask you to provide an overview on the type of UK-authorized fund vehicles available, how they’re structured, and the appeal of using such funds structures?

Types of UK-Authorized Fund Vehicles Available

Yeah, of course. Hi, Neil. Yeah. So, the first stage when you’re thinking about setting up a family vehicle is what is going to be the structure of the fund. And most families will tend to be choosing between a corporate vehicle or a trust vehicle.

The Corporate Vehicle

And the corporate option is known as an OEIC, an Open-Ended Investment Company. Importantly, it’s got its own set of rules. So, it’s not like a normal Companies Act company for those of you who are familiar with ordinary companies. It is an investment company and it has its own set of rules. The investors are shareholders in that company, so they have no beneficial interest in the underlying assets. And the OEIC would be operated by an authorized corporate director such as Waystone and a depository would hold the assets on behalf of the fund.

The Trust Vehicle

So, that’s the corporate vehicle. The authorized unit trust would be the other obvious choice for families. And that works in a very similar way. And for all intents and purposes, it’s very, very, very similar. And that would be constituted by a declaration of trust. And investors hold units in the fund and become unit holders rather than the shareholders. And again, it would be managed by a trust manager such as Waystone and investments will be held this time by a trustee, but will be performing very similar functions to a depository. For completeness, there is also a contractual type of scheme, although that is tax transparent and not usually appropriate for use by families. So, you pick your structure, and then you pick your overlay, your regulatory overlay. And there are sort of five key regulatory overlays that are available in the UK, and which one you pick dictates how robust the investment and borrowing restrictions are on the funds that you’re going to be running.

5 Key Regulatory Overlays Available in the UK

UCITs

Now, really, one of those is the UCITS overlay, which isn’t particularly relevant to families. It’s the most narrow investment and borrowing powers that are available. And so it’s not really something you would typically look at in a family structure. And so typically, you’d start with what’s known as a NURS, a Non-UCITS Retail Scheme, which, broadly speaking, allows families to invest in listed assets. You can have a little bit of non-listed in there, a small amount of real estate, a small amount of commodities. But it is quite restrictive. And then moving along the spectrum, there’s such thing as a NURS FAIF, which is the same as a NURS, but FAIF stands for Fund of Alternative Investment Funds. And that gives you a little bit more flexibility to invest in other fund vehicles such as hedge funds. So, for families looking to invest in hedge funds, that would be a good regulatory overlay to choose.

Long-Term Asset Funds & Qualified Investor Scheme

And then there are two more regulatory overlays, the long-term asset funds and the qualified investor scheme, which are much, much more flexible and would be really interesting for families, I’m sure, but the problem with them is that they require genuine diversity of ownership. So it doesn’t work to use those structures, typically, with families because, obviously, the family members are all related. So, it’s the NURS or the NURS FAIF for the most part that families would typically be choosing.

So, that’s sort of the structure and the regulatory overlay. Why even go down this route in the first place? Well, I think it’s quite helpful for family planning purposes to offer a kind of unitized vehicle like a UK-authorized fund because to the extent that there are changes in family members, marriages, divorces, new children, etc., etc., it’s very flexible. You can issue more units, you can take units away from people. It’s quite easy to deal with changes in family members through this kind of vehicle. It also offers family members access to a wider range of assets than they might otherwise be able to invest in on their own. So, whilst sometimes maybe the patriarch or the matriarch of the family might well be classed as a professional investor for regulatory purposes, perhaps a lot of the family members wouldn’t and so wouldn’t always be able to access the types of assets that can be held through these types of vehicles.

And it also helps in terms of continuity. So, these types of vehicles would typically appoint an investment manager in order to manage the assets of the fund. And you can replace that investment manager. So, if you decide that you don’t like the strategy that that investment manager has been pursuing or it hasn’t been doing well, you can remove that investment manager and appoint a new one. So, that’s quite useful. And finally, it’s really helpful, I think, to have a UK-authorized fund from a general credibility perspective. The funds, as I say, will be authorized by the Financial Conduct Authority, so it’s quite nice, I think, and comforting to have that sort of stamp of approval from the UK regulator in respect of the family fund.

Brilliant. Thanks, Lora. That’s a great start, and a little bit more on the regulatory elements later on. Turning now to Peter. Just to pick up on Lora’s reference to the open-ended investment companies, Peter, how would you explain in simple terms the tax profile of an OEIC?

Tax Profile of Holding an Investment Portfolio Direct

Thanks, Neil. To explain the tax profile of an OEIC, it’s worth just talking through the tax profile of holding an investment portfolio direct, so outside of an OEIC to compare and contrast. So, outside of an OEIC any gains realized is subject to capital gains tax. Any income will be subject to tax as it arises, and any investment fees usually with VAT-added are generally paid out to the already taxed income. This position is slightly different depending on whether the investments are held by an individual, in a company, or within a family trust. It means that the holder of the investments is open to the impact of any tax changes, which could affect their investment returns over the longer-term. It’s worth bearing in mind that we still have the lowest rate of capital gains tax since the tax was introduced in 1982 other than 2 years after, following the financial crisis, when it reduced to 18%.

Advantages of an OEIC Tax Profile

1. Sale of Investments not Subject to Gains Tax

So, comparing this to an OEIC, there are three key tax advantages of an OEIC. Firstly, if investments are held within OEIC, the sale of those investments are not subject to capital gains tax, which means that investments can be sold within it at a profit and the gross proceeds can be reinvested by the investment managers. Capital gains tax is only paid when the family member sells their shares in the OEIC, not to any individual investments held within the OEIC are sold. As a result of this, if it were appropriate to change investment manager, as Lora explained in the future, this can be done without triggering capital gains tax, something which is often a significant barrier when portfolios are held personally.

2. Significant Savings in Investment Management Fees

Secondly, there’s the treatment of the investment management fees. Within the OEIC, these are usually exempt from 20% VAT, which can deliver significant savings. The saving on the VAT could cover the annual costs of maintaining the OEIC. Thirdly, although the income generated within the OEIC in the form of dividends and interest is still taxed on the shareholders in the OEIC as that income arises, the amount that they’re taxed on is netted off by the fees from the investment managers and the authorized corporate director. An individual would, therefore, effectively get income tax relief for the fees, so reducing their exposure to income tax, which for next month will be at the top rate of just over 39% for dividends.

So, we help families looking at forming OEICs to model how an OEIC might fit into and support their wider plans. We factor in and adjust a number of variables to this modeling, including the impact of tax changes, personal profiles, family succession plans, anticipated investment performance and fees. And this precise modeling is helpful in itself for a family in deciding whether an OEIC is appropriate for them. And it also helps the family to stress test and validate their wider plans and objectives. The impact of an increase in capital gains tax would have a really significant impact over the longer-term on portfolios held outside of an OEIC. And over a 20-year period, you could see a significant upside in the value of the investments if held within the OEIC rather than directly.

Thanks, Peter. And just sticking with the tax theme while you’re on a roll, what are the key tax issues and sensitivities to be aware of?

So, I’d say a key tax issue to be aware of is that we’re focusing today on the UK tax profile. And the overseas jurisdictions can view OEICs very differently, particularly in the U.S. If a family member is potentially looking to be moving overseas, then it’s important to ensure that the tax position is understood and carefully planned for. More generally, they should very much form part of the family’s longer-term plans. And this is really important to model how an OEIC would fit in with the family now and in the future. This should factor in exposure to estate taxes of whatever forms they may take over the next few decades. Assuming the investments within the OEIC grow in value, then what is invested now could easily have doubled in value over a 20-year period even with fairly modest annual returns. If 40% of that increase will ultimately be paid over inheritance tax, it means that if families are exploring establishing an OEIC, they need to discuss and agree their family strategy which is often a joint exercise with a tax advisor, their lawyer, and their investment advisor.

Brilliant. Thanks, Peter. Rob, just bringing things closer to home, I guess, for you and I in terms of the role of the ACD, perhaps I can turn it to you to provide an appreciation of the role of the ACD as well as the various parties appointed within a fund structure and the respective roles that they play?

The Role of the Authorised Corporate Directors

Absolutely. Thanks, Neil. So, authorized corporate directors, ACDs, are responsible for the running of an investment fund. They have a duty to act in the best interests of the fund’s investors and assure that the fund is well managed in line with regulations and with the investment objectives and policies set out in its prospectus. ACDs can delegate many of the day-to-day functions needed to keep a fund running, but they retain the legal and regulatory responsibility for all of these activities and must effectively oversee that the activities are being performed properly. Independent ACDs do not have the investment management expertise to manage the portfolios, therefore, there is a full delegation to investment management firms who will build and run portfolios in line with the family’s investment objectives. Under this delegation, the ACD enters into an investment management agreement with the appointed firms where regulatory obligations and expectations are set out.

So, this oversight has been invisible to investors over the years. However, with the introduction of a new piece of regulation entitled “Assessment of Value,” families can now access a full independent report prepared by the ACD, providing commentary on elements such as performance, quality, and costs and charges. So, in terms of the third parties, a depository is appointed and oversees the work of the ACD and is responsible for making sure that assets are kept safely for which they often appoint a custodian. Auditors certify that each fund’s report and accounts present a true and fair record of the fund such as investment holdings and details of any assets that have been bought and sold in the period. Although it is recognized that there is regulatory requirement for the appointments as I’ve mentioned, all parties are servants to the fund and, therefore, to the families that invest in these structures.

Thanks, Rob. And we’ll come back in a little bit to talk a bit more about the assessment of value and the impact that that’s had on the ACD. Lora, just picking up on the point you raised earlier and we know in this industry we’re not too far away from the regulator, but can I turn it back to you just to ask if there are any other regulatory considerations?

Other Regulatory Considerations

Yeah. I think one of the biggest issues when we talk to families about setting up OEICs, is really around the level of control that they’re able to exert over the funds, because from a commercial perspective, clearly, it is the family’s funds. The family wants to make decisions around the mandate and, you know, be involved in the selection of investment managers, etc., etc. But from a regulatory perspective, the FCA considers the funds to be that of the ACD. And that’s very important for families to understand. So, whilst families can have a say in how the fund is run, they can’t really have a complete veto around certain aspects of the way it is run. And so the way that sort of control tends to be documented is through what’s known as a Sponsorship Agreement. And that agreement will set out the extent to which the families can have a say on various aspects of the fund’s operation.

The other thing to bear in mind in relation to these types of structures is that the downside of having an FCA-authorized fund is that when you make certain changes to the fund, you do sometimes need FCA approval for those changes and sometimes you do need either to give notice to investors or investor consent. So, sometimes certain changes can’t be made overnight to these types of vehicles, sometimes there needs to be a bit of lead-in time in order to get regulatory consent for changes. And normally, that tends to be a month that it takes the regulator to approve changes to a fund. Obviously, the concept that investor notification or investor consent has certain changes is a bit of an odd one in this context because typically the changes that have been requested by the family, but nonetheless, these regulatory hoops do need to be jumped through, unfortunately.

The only other thing I guess I wanted to mention in this context is that these funds are typically daily dealing funds. They can be weekly dealing or maybe even fortnightly dealing, but what I mean by that is that investors do need to be given the opportunity to get out, to sell their shares or units regularly. And that does mean that a certain level of liquidity is required within the fund. And it’s always important to remember that. There’s no real ability to lock in investors for a long, long period of time. And normally that’s fine in these family situations, but it is important to remember that that is a feature of these funds.

Brilliant. Thanks, Lora. Just picking up on that, the emphasis there on the family and shifting gears towards the end investor of the family.

Peter, how do you see families using OEICs as they plan for their futures?

So, families are planning for their future factoring in a variety of aspects, whether it be wealth preservation, funding new ventures, succession, tax governance, efficiency, asset protection, etc., etc. And often families will hold their investments in a number of different pots where they could be held personally in trusts, in investment companies, in pensions, in ISIS. They may have investments with multiple investment managers and they could receive separate investment reports for each of those pots. And this can make it really difficult to stand back and track how those investments are performing.

So, OEICs are essentially akin to a tax-efficient wrapper for consolidating investment portfolios. And they perform a really key function in helping families achieve their wider goals, and, certainly, not just focusing on tax efficiency. Each family member trust company, as Lora mentioned, can hold shares in the OEIC. Rather than holding their individual portfolios, the tax returns for all of the individual family members and entities become much more straightforward overnight, holding just the one investment in the OEIC. The investment managers then run their portfolios within the OEIC, helping to simplify the reporting and the visibility for the family stakeholders. So, the family can see one share price for the consolidated investments, but they can still have visibility on each investment manager’s performance in a consistent manner, seeing each manager’s performance through the lens of the OEIC and its consolidated reporting supported by the ACD.

And this pooled approach to investments then helps families to work together in tracking and monitoring their investments with the guidance and support of the ACD who can tailor the information reporting to the family’s needs. It can also be a great way of helping to build younger generations’ engagements and awareness of investments in a family fund that’s in a controlled manner where they can all be involved with it together. So, the running of the OEIC with the support of the ACD can really complement and support the family’s wider governance plans. The ACD can track and monitor the performance of investment managers and arrange periodic meetings between the family and the investment managers so that families are fully informed and updated. The fact that an OEIC is open-ended also means that the OEIC is not set in stone at the outset as a family investment company might be. And additional shares can be acquired as funds become available, adjusting to the changing circumstances of the family over multiple generations. So, an OEIC, it is a regulated investment fund. It has a degree of public visibility. So, it needs to be undertaken as a long-term vehicle in a carefully considered way, rather than being viewed as a short-term tax-efficient vehicle, if you’d like.

Brilliant. Thanks, Peter. And Rob, you mentioned in the introduction your experience with family councils. Perhaps you can provide an overview on the establishment of sub-councils in relation to this type of fund structure.

Establishment of Sub-Councils

Absolutely. Thanks, Neil. Yeah. There are many funds structures that are set up for families that have multiple investment managers appointed to run the portion of the portfolio. So, I guess always in keeping with the relevant rules many families choose to diversify their portfolios with the appointment of different wealth managers and also harnessing the use of specific sector expertise. So, as Peter correctly stated, the ACD will facilitate those periodic meetings between families and investment managers so that family are fully informed and updated. So, do remember that families are getting access to investment managers within a regulated UK funds structure which is a key consideration in terms of investing in these structures.

The ACDs can also provide fund-level reporting and walk-through findings within the independent assessment and value statement. So, to maximize the client experience, a family council will be created, and in attendance at these periodic meetings will ordinarily include family members across generations, family associates, appointed tax advisors, investment managers, and the appointed ACD on the funds. Families may have wider interests with the parties mentioned above, therefore, it may be an appropriate forum to discuss other matters depending on the required audience.

Brilliant. Thanks, Rob, and thank you for a very detailed conversation. We’ve covered a lot of ground in the last half an hour. We’ve covered investment options and structuring, tax profiling, courtesy of Peter’s updates, creation of single-family council, and, of course, the role of the ACD. With that, I’d like to thank you all for attending, and to Peter, Lora, and Rob, specific thanks for sharing insights on family investment funds. If you do have further questions or require further information on this particular subject, it’s a hot one at the moment here at Waystone, please get in touch with us and we can put you in touch with the relevant panelist. The webinar has been recorded and will be sent around to you all in the next couple of days. The recording will also be available via the Waystone website. A transcript of the conversation is also being created and will be shared via the same media. Thanks very much for joining, and I wish you a good rest of the day.