The facts on investing in foreign collective investment schemes

Introduction

Over the past few years, investors have been strongly encouraged to invest abroad as a means of diversifying risk and hedging against the depreciation of the rand and domestic inflation. With foreign investments there are number of additional dynamics to take into account. Aside from the numerous funds to choose from, there may be different share classes, confusing fund structures, different pricing systems and greater tax implications.
The purpose of this fact sheet is to address these dynamics and shed some light on how to go about investing in foreign collective investment portfolios, what kinds of funds are available and the tax implications thereof.

How to go about investing in foreign collective investment schemes (FCIS)

You can invest in a locally registered collective investment portfolio fund with international exposure or you can invest in foreign markets by using your R2 000 000 once-off foreign investment allowance. Before you can use your foreign investment allowance you need to ensure that you meet the following requirements:

1. You must be a natural person of at least 18 years of age. This means that you cannot make the investment through a trust, close corporation or company;Y
2. You need to apply at your local SARS Branch office where you are registered for Income Tax purposes for a tax clearance certificate.
3. SARS will send the tax clearance certificate directly to authorised dealer handling the actual transfer/investment of the funds.

If you have decided to invest in a foreign fund there a number of organisations you can approach. The offshore divisions of South African CIS management companies and banks offer funds and there are also a number of foreign companies who have been approved by the FSB to sell their products in South Africa. This allows for a relatively easy entry into foreign investment for South Africans.

It is strongly advisable to invest in a foreign fund that has been approved by the FSB.

A list of approved FCIS and their funds is available on the FSB website on www.fsb.co.za. Schemes which are members of ASISA can be found on the ASISAI website at www.asisa.org.za

The importance of investing in approved offshore investment schemes

In terms of Section 37A of the Collective Investment Scheme Control Act, no 54 of 1981, no FCIS may be marketed in South Africa unless they are approved by the FSB. This regulation does not prevent you from taking the decision to invest in an offshore collective investment portfolio or any other foreign investment that is not approved by the FSB but it does prohibit anyone from advising you to invest in any unregistered collective investment portfolio funds.

The requirement that funds have to be approved by the FSB was introduced to ensure that:

1. The fund operates in a regulatory environment of at least the same and/or similar standard as in South Africa;
2. The risk profile of the fund is not significantly higher than similar funds offered in South Africa; and
3. The investments offered for sale are similar to those offered by a local management company

All of the above ensure that local investors are afforded maximum protection.

Different types of investment funds

Selecting an appropriate foreign fund can prove to be most challenging. Not only is there a wide choice of investments to choose from, but also the terminology used to describe the funds available is often confusing. Often terms such as mutual funds, collective investment portfolios, OEICs and SICAVs are used interchangeably. The ones most commonly found in the foreign schemes and funds on offer in South Africa include:

1. Unit trust funds or collective investment schemes (CISs)
2. Open Ended Investment Companies (OEICs)
3. Sociéte d’Investissement Collectif à Capital Variable (SICAVs)

Mutual funds

Unit trust funds / collective investment scheme funds

Foreign collective investment scheme portfolios are similar to that of local collective investment scheme portfolios in terms of structure and management. Your money is pooled with other investors who have similar investment objectives. Experienced investment managers invest this pool of money in a wide range of international shares, bonds and other financial instruments. The total value of the pool of invested money is split into equal portions called units. The unit price is dependent on the market value of the underlying assets in which the pooled money is invested and is calculated at defined periods which may be daily, weekly, bi-monthly or monthly. The value of the collective investment portfolio will rise and fall because it is linked to the value of shares and other instruments in which the collective investment portfolio is invested.

The assets of the collective investment portfolio fund are held in trust for the benefit of the underlying investors. The trustee/custodian is placed under fiduciary responsibility to ensure that the fund is managed in accordance with its investment objective.

Open Ended Investment Companies (OEICs)

Up until May 1997 only two types of investment vehicles were available in the UK, namely collective investment portfolios and investment trusts. In May 1997 another type of investment fund called an Open Ended Investment Company or OEIC was introduced. OEICs are similar in nature to collective investment portfolios. In Europe, OEICs are registered mainly in jurisdictions such as the Channel Islands, Isle of Man and Ireland, who are regulated by the UK Financial Services Authority.

Unlike collective investment scheme portfolios where investors purchase units in a portfolio, participation rights of investors are obtained by the purchase of shares in the company. As new investors enter the scheme, new shares are issued – hence the reference to “open-ended”. The company has no predefined termination date, it can continually issue or buy back its own shares and therefore has a variable share capital. It uses the basic corporate structure commonly used for investment funds in Continental Europe and the United States.

Many managers are looking to convert existing portfolios into OEICs because the new vehicle is more flexible.

The custodian is placed under fiduciary responsibility to ensure that the fund is managed in accordance with its investment objective.

d’Investissement Collectif à Capital Variable (SICAVs)

SICAVS are very much the same as OEICs only that these schemes are typically registered in French speaking countries such as Luxembourg and France. They are also open-ended investment companies and are required to fulfil certain conditions as prescribed by the European Directive on UCITS (please see explanation below).

The investment company usually delegates the investment and administration tasks to a third party and typically has no staff of its own other than a Board of Directors (or an Authorised Corporate Director in the case of some OEICs), which carries the overall responsibility for all matters regarding the fund. The depositary, similar to a trustee of a portfolio, is charged with the safekeeping of the fund’s assets and with the monitoring of management activities, which must always be taken on the sole interests of the investor.

European Union (EU) Directive on UCITS

UCITS is an abbreviation for “Undertaking for a Collective Investment in Transferable Securities” and describes an investment fund, typically an open-ended fund such as a SICAV and an OEIC that complies with the EU Directive on UCITS.

The European Directive 85/611/EEC of 20 December 1985 and, as amended, aims to harmonise the laws, regulations and administrative provisions relating to UCITS. The directive has the dual objective:
To level the competitive conditions among UCITS at the European level and to ensure an effective and uniform protection of investors.
In addition, the Directive also attempts to simplify cross border marketing and to help bring about a European capital market.

The EU Directive only covers those foreign schemes that:

1. Are domiciled in a Member State of the European Union (EU) and European Economic Area (EEA)
2. Are publicly offered
3. Repurchased at net asset value at the unitholder’s/shareholder’s request
4. Invest in transferable securities
5. Operated on the principle of risk-spreading
6. Entrust their assets to a depositary/custodian/trustee.
7. Investment funds that fulfill these requirements can be freely marketed across borders in 18 EEA countries without further authorisation.

Mutual fund scheme

Mutual funds are offered in the United States and are run pretty much on the same basis as OEICs. Like OEICs and SICAVs, a mutual fund is an investment company that pools money from investors and invests in a diversified portfolio of securities. Mutual fund investors buy a participatory interest that represents an equal participation in all of the fund securities.

Mutual funds are also open-ended by nature - that is the fund continually offers new shares to investors.

Different types of fund structures

Fund structures are continually evolving to keep up with changing consumer needs. In foreign markets different structures such as umbrella schemes, funds of funds and feeder funds are used as they allow the provider the flexibility of adding sub-funds to meet different investor needs. Collective investment schemes or CIS’s can operate as umbrella schemes and as feeder funds.

Umbrella Scheme

By their very nature OEICs and SICAVs can operate as umbrella structures. Within the umbrella scheme, investors have access to the OEICs or SICAVs funds, each with different investment objectives as well as to the funds of other companies. In other words the companies’ own funds as well as those of other companies are offered within the umbrella scheme.

For example, under one umbrella there may be a fund investing in European company shares, a second in UK Government or corporate bonds, a third in North American shares and so on.

Each fund is represented by a different class of share within the OEIC or SICAV. In most instances the shareholder may switch or convert from one class of share to another at zero or reduced costs. A further characteristic is that the share classes offered for a particular fund may be issued in currencies other than the currency of the scheme e.g. in a UK Sterling scheme this means that investors would be able to buy Euro or US Dollar denominated shares if this was more suitable for them.

Most schemes also provide for additional funds to be added, by issuing a new class of shares. Where this does occur, an amendment is made to the prospectus of the company. Should the initial charges for a new class of share be higher than those of the existing classes of shares, provision is made for a deferred initial charge, being the difference between the original charges paid and the charges on the new fund.

All income received and interest earned in an umbrella fund is accumulated in order to enhance the capital value of the underlying funds. In most cases no dividends are paid.

Feeder funds

These funds allow the investor entry through one fund into an underlying fund, which can be registered as an OEIC/SICAV/mutual fund/unit trust in the same or other jurisdictions.

Fund of funds

A fund of funds is similar to the feeder fund but investments are placed into a number of underlying funds run either by the management group itself or by other fund management companies. The selection of underlying funds is therefore done on a managed basis, according to the specific mandate of the fund.

Tax implications

Any income earned from a foreign investment is taxable. Unlike dividends earned from investments in South Africa, which are tax exempt, dividends you receive from foreign investments are taxable as income.

If you are a South African resident, the same Capital Gains Tax (CGT) rules apply to your offshore collective investment portfolios in the same way that it applies to your South African collective investment portfolios, that is, any capital gain on your investment may be subject to taxation.

Reporting on performance and pricing of offshore funds:

Please note that in terms of SA legislation, SA funds are currently only allowed to deduct three types of expenses from the income of the fund (i.e. audit fees, service fee and taxes). With foreign funds, other expenses may also be deducted and could include management, custodian, domiciliary fees and administration expenses.

If yo are considering foreign collective investment portfolios, keep the following in mind:

• Funds, which are managed from what is known as a foreign tax haven, are still subject to little or no tax. However, interest and dividends are taxable in the hands of the unit holder. As with domestic collective investment portfolios, capital gains tax may be payable on capital gains in the hands of the unit holder. Also note that investment secrecy is diminishing. Lack of or incomplete disclosure regarding withholding taxes – it is often difficult to track withholding taxes levied on the returns of the underlying assets. If the tax cannot be tracked you cannot make a claim for a tax credit.
• There are no exchange controls, so you can move your money in and out of different countries and currencies freely.
• Wide investment choice.
• You can choose from an array of investment products and companies.
• Up until quite recently, you could only invest lump sums into foreign collective investment portfolios and fairly large amounts of money were required to meet the minimum investment requirements. It is now possible to access funds with more affordable lump sum investments and make monthly debit order payments.
• You can invest in non-registered products, but you cannot expect the protection of local regulators.
• Decide what are your investment objectives, risk tolerance and your time frame
• Take a careful look at the initial fees, ongoing management fees as well as any specific conditions relating to early withdrawals from the fund i.e. exit penalties.
• Determine how much capital you have to invest and how much you will allocate to each investment you make. Take into account the returns you require and the level of risk you can tolerate.
• The overall direction of global markets. Also give consideration to how liquid the markets are should you need to get out of a fund quickly.
• The currency of the funds you would like to invest in is important. By ensuring that your portfolio is diversified in terms of currency as well as style, you can reduce currency risk.
• Analyse the level of volatility of the fund i.e. the fluctuations of return to determine if you can tolerate the level of volatility as a measure of risk.