Many hands make light work
08 February 2017
In the search for alpha, appointing an investment fund and a management company can bring myriad benefits, says Eduard von Kymmel of VP Bank
Image: Shutterstock
Alpha, often called the ‘holy grail’ of investing, receives a lot of attention from managers as well as investors.
Alpha is expected to be found by exploiting market inefficiencies and is mostly referred to the abnormal rate of return on a security or portfolio in excess of what would be predicted by an equilibrium model such as, for example, the capital asset pricing model (CAPM).
In a nutshell, alpha is mostly referred to in the context of the active allocation of assets.
However, did you ever think about market inefficiencies which can be taken advantage of through the professional operation of an investment fund?
Apart from the recent market turbulences and the connected mistrust from regulators and investors of offshore funds, there are many more advantages referring to operational economies of scale that can be used to generate additional returns by establishing and managing an investment fund in Liechtenstein or Luxembourg, in collaboration with a local management company.
Managing regulations
These days, regulation is getting a more and more strategic discipline, but how can the growing flood of regulations be managed? The ongoing monitoring of the various upcoming and steadily changing regulations causes additional costs and affects asset managers in their day-to-day operations.
Therefore, outsourcing this task to a management company by establishing and managing an investment fund could help not only in boosting the operational efficiency of the asset manager, but also assist in gaining a strategic advantage over competitors, while still being able to operate a lean setup.
Talking about outsourcing, it also needs to be mentioned that all the back- and middle-office tasks—administration, compliance, reconciliation, risk management, audit management, correspondence with authorities and regulators—which otherwise have to be taken care of by the asset manager, can be farmed out to the management company of the investment fund.
Investment funds can therefore be seen as a valid and highly attractive outsourcing opportunity for asset managers. By establishing and continuously managing an investment fund structure in Liechtenstein or Luxembourg, the asset manager will be enabled to transform previously fixed costs into variable costs, thereby reducing overheads.
In addition, asset managers will be able to use their existing resources to fully focus on their key functions to the utmost extent, namely managing the assets according to their mandate and distribution.
Reducing risks
Investor protection has to be mentioned in one breath with regulation, given that this is the core mandate of any investment fund as well as all the stakeholders.
Since the management company and depository are liable towards third parties, duties and responsibilities will be transferred to the management company and the depository of the investment fund. Therefore, apart from lowering overheads, liability risks and the costs in conjunction with these risks can also be significantly reduced.
Moreover, the investors are protected through the ‘deep pockets’ of the management company as well as the depository, which in turn leads to strong corporate governance provided to the investment fund, the asset manager and finally the investors.
Taking into account the investors’ perspective further, investments into an EU-regulated investment fund provides them with clear guidelines when it comes to the protection of their interest as well as the handling of complaints and escalation procedures.
Enabling diversification
In terms of the allocation of assets, investment fund structures can also be beneficial for asset managers and investors, since the desired diversification might only be achieved through a substantial investment amount.
This is especially given for fixed income securities as well as various alternative investment strategies. Consequently, the asset allocation of the clients allows for an enhancement of their risk/return profile and for a portfolio better addressing their needs through the utilisation of an investment fund.
Compared to an operation without any investment fund structure, the equal treatment of investors might be difficult for asset managers managing various different mandates held with numerous banks. Likewise, the different portfolios will suffer from slippage and the comparison between the various portfolios will get considerably more difficult.
Again, an investment fund can easily address this issue, since all the clients’ assets will be held at the same depository and trades will be executed at the same time.
The various client needs can then be addressed on the level of the different share classes in order to treat every investor within a given share class equally.
Pan-European distribution
By using an EU or European economic area (EEA) fund structure, the ongoing access to the European single market can be significantly facilitated as well as guaranteed on an ongoing basis.
Additionally, when it comes to the commercialisation of an investment strategy, an investment fund provides clear guidelines on how, and to whom, to market the products to as well as the admissibility of the marketing materials used to do so.
Nevertheless, distribution also comes with additional workload in terms of the required resources needed to administer the relationships stemming from a pan-European distribution.
Again, the management company of an investment fund can help to take care of these relationships, thereby nominating and monitoring the relevant delegated counterparties as well as potential changes in the legal or regulatory landscapes.
Taking into consideration the increasing demand for transparency as well as regulatory needs for various reports, an investment fund domiciled in a jurisdiction of the EU or EEA also disposes of reports that are in line with the requirements set out by the European regulators, allowing a standardised reporting of the activities of the fund to its investors which exactly meet their demand.
Moreover, specific reports demanded by the clients (for example, reports required by the German Insurance Supervision Act, reports according to specific account rules, and the like) can also be provided by the management company of the fund within a reasonable amount of time without putting additional workload towards the asset manager.
Efficient tax management
Notwithstanding are certain tax advantages, especially when it comes to reallocating assets, the utilisation of derivatives as well as the exploration of double tax agreements and reclaiming withholding tax.
Again, this directly affects the overall performance of the investors’ portfolio and potentially enhances alpha by increasing the returns through efficient tax management, which will be overtaken by the management company to allow the other stakeholders involved to focus on their core functions.
In addition, certain privileges compared to direct investments directly influencing the investors’ personal tax situation may be achieved through the utilisation of an investment fund.
In order to be able to gain from these opportunities, certain systems allowing the production of the required reports, as well as the coordination of the required service providers, authorities and other stakeholders, have to be in place.
Once more, these tasks can be carried out by the management company within an EU or EEA investment fund.
Professional expertise
Besides effects that are directly measurable in terms of cost reductions for the asset manager and the investors, both the asset manager and the investors will be able to profit from the expertise provided by dedicated management companies professionally servicing asset managers and investors in their daily business.
This may cover the whole spectrum from input referring to the structures operated to supporting the daily operations, which can be of specific advantage when it comes to certain investment strategies that might go beyond the traditional universe of stocks, bonds and cash.
Even more, it is not only about ‘do what you can do best—outsource the rest’, but also about what the clients demand: independent operations; separation of powers; and a reliable, flexible and extensible infrastructure. These are key to growth and to a return enhancement, both for the asset managers as well as for the investors.
Variety of advantages
To conclude, on the one hand, investment funds offer a variety of advantages that can help asset managers to grow their business organically by providing tailor-made solutions while still being able to operate lean structures. In addition, a key condition to institutional growth is independent operational staff to provide the check and balance functions needed to secure the value of their investments.
On the other hand, investors are able to gain from advantages offered through the professional operation of an investment fund by making the most of the tools and resources available to the utmost extent. Therefore both investors and fund managers, are able to benefit from the generation of additional alpha by boosting the operational efficiency.
To express it in a different way, a management company is the all-rounder which is able to provide an action plan for all contingencies in a reasonable amount of time, thereby enabling future growth, an increase in returns and more efficient operations.
Alpha is expected to be found by exploiting market inefficiencies and is mostly referred to the abnormal rate of return on a security or portfolio in excess of what would be predicted by an equilibrium model such as, for example, the capital asset pricing model (CAPM).
In a nutshell, alpha is mostly referred to in the context of the active allocation of assets.
However, did you ever think about market inefficiencies which can be taken advantage of through the professional operation of an investment fund?
Apart from the recent market turbulences and the connected mistrust from regulators and investors of offshore funds, there are many more advantages referring to operational economies of scale that can be used to generate additional returns by establishing and managing an investment fund in Liechtenstein or Luxembourg, in collaboration with a local management company.
Managing regulations
These days, regulation is getting a more and more strategic discipline, but how can the growing flood of regulations be managed? The ongoing monitoring of the various upcoming and steadily changing regulations causes additional costs and affects asset managers in their day-to-day operations.
Therefore, outsourcing this task to a management company by establishing and managing an investment fund could help not only in boosting the operational efficiency of the asset manager, but also assist in gaining a strategic advantage over competitors, while still being able to operate a lean setup.
Talking about outsourcing, it also needs to be mentioned that all the back- and middle-office tasks—administration, compliance, reconciliation, risk management, audit management, correspondence with authorities and regulators—which otherwise have to be taken care of by the asset manager, can be farmed out to the management company of the investment fund.
Investment funds can therefore be seen as a valid and highly attractive outsourcing opportunity for asset managers. By establishing and continuously managing an investment fund structure in Liechtenstein or Luxembourg, the asset manager will be enabled to transform previously fixed costs into variable costs, thereby reducing overheads.
In addition, asset managers will be able to use their existing resources to fully focus on their key functions to the utmost extent, namely managing the assets according to their mandate and distribution.
Reducing risks
Investor protection has to be mentioned in one breath with regulation, given that this is the core mandate of any investment fund as well as all the stakeholders.
Since the management company and depository are liable towards third parties, duties and responsibilities will be transferred to the management company and the depository of the investment fund. Therefore, apart from lowering overheads, liability risks and the costs in conjunction with these risks can also be significantly reduced.
Moreover, the investors are protected through the ‘deep pockets’ of the management company as well as the depository, which in turn leads to strong corporate governance provided to the investment fund, the asset manager and finally the investors.
Taking into account the investors’ perspective further, investments into an EU-regulated investment fund provides them with clear guidelines when it comes to the protection of their interest as well as the handling of complaints and escalation procedures.
Enabling diversification
In terms of the allocation of assets, investment fund structures can also be beneficial for asset managers and investors, since the desired diversification might only be achieved through a substantial investment amount.
This is especially given for fixed income securities as well as various alternative investment strategies. Consequently, the asset allocation of the clients allows for an enhancement of their risk/return profile and for a portfolio better addressing their needs through the utilisation of an investment fund.
Compared to an operation without any investment fund structure, the equal treatment of investors might be difficult for asset managers managing various different mandates held with numerous banks. Likewise, the different portfolios will suffer from slippage and the comparison between the various portfolios will get considerably more difficult.
Again, an investment fund can easily address this issue, since all the clients’ assets will be held at the same depository and trades will be executed at the same time.
The various client needs can then be addressed on the level of the different share classes in order to treat every investor within a given share class equally.
Pan-European distribution
By using an EU or European economic area (EEA) fund structure, the ongoing access to the European single market can be significantly facilitated as well as guaranteed on an ongoing basis.
Additionally, when it comes to the commercialisation of an investment strategy, an investment fund provides clear guidelines on how, and to whom, to market the products to as well as the admissibility of the marketing materials used to do so.
Nevertheless, distribution also comes with additional workload in terms of the required resources needed to administer the relationships stemming from a pan-European distribution.
Again, the management company of an investment fund can help to take care of these relationships, thereby nominating and monitoring the relevant delegated counterparties as well as potential changes in the legal or regulatory landscapes.
Taking into consideration the increasing demand for transparency as well as regulatory needs for various reports, an investment fund domiciled in a jurisdiction of the EU or EEA also disposes of reports that are in line with the requirements set out by the European regulators, allowing a standardised reporting of the activities of the fund to its investors which exactly meet their demand.
Moreover, specific reports demanded by the clients (for example, reports required by the German Insurance Supervision Act, reports according to specific account rules, and the like) can also be provided by the management company of the fund within a reasonable amount of time without putting additional workload towards the asset manager.
Efficient tax management
Notwithstanding are certain tax advantages, especially when it comes to reallocating assets, the utilisation of derivatives as well as the exploration of double tax agreements and reclaiming withholding tax.
Again, this directly affects the overall performance of the investors’ portfolio and potentially enhances alpha by increasing the returns through efficient tax management, which will be overtaken by the management company to allow the other stakeholders involved to focus on their core functions.
In addition, certain privileges compared to direct investments directly influencing the investors’ personal tax situation may be achieved through the utilisation of an investment fund.
In order to be able to gain from these opportunities, certain systems allowing the production of the required reports, as well as the coordination of the required service providers, authorities and other stakeholders, have to be in place.
Once more, these tasks can be carried out by the management company within an EU or EEA investment fund.
Professional expertise
Besides effects that are directly measurable in terms of cost reductions for the asset manager and the investors, both the asset manager and the investors will be able to profit from the expertise provided by dedicated management companies professionally servicing asset managers and investors in their daily business.
This may cover the whole spectrum from input referring to the structures operated to supporting the daily operations, which can be of specific advantage when it comes to certain investment strategies that might go beyond the traditional universe of stocks, bonds and cash.
Even more, it is not only about ‘do what you can do best—outsource the rest’, but also about what the clients demand: independent operations; separation of powers; and a reliable, flexible and extensible infrastructure. These are key to growth and to a return enhancement, both for the asset managers as well as for the investors.
Variety of advantages
To conclude, on the one hand, investment funds offer a variety of advantages that can help asset managers to grow their business organically by providing tailor-made solutions while still being able to operate lean structures. In addition, a key condition to institutional growth is independent operational staff to provide the check and balance functions needed to secure the value of their investments.
On the other hand, investors are able to gain from advantages offered through the professional operation of an investment fund by making the most of the tools and resources available to the utmost extent. Therefore both investors and fund managers, are able to benefit from the generation of additional alpha by boosting the operational efficiency.
To express it in a different way, a management company is the all-rounder which is able to provide an action plan for all contingencies in a reasonable amount of time, thereby enabling future growth, an increase in returns and more efficient operations.
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