Using Tax Transparent Funds to improve investment efficiency Common Contractual Funds and why you should consider them For Professional Clients only Using Tax Transparent Funds to improve investment efficiency // Page 2 Executive summary For both investors and managers exploring tax transparent funds, and specifically Common Contractual Funds (CCFs), is critical for two key reasons: • Investors could be losing valuable basis points on their funds’ performance • Managers should launch CCFs to avoid their tax exempt clients losing money Tax efficiency of pooled funds has been neglected Expertise needed to create a Tax Transparent Fund Both large and small institutional investors continue to use Making a fund tax transparent is a complex process which requires pooled funds to implement their portfolio strategies. But until tracking dividend income as well as applying the relevant tax now few have considered whether these funds have been built treaties to the right investor. Technological developments have to be withholding tax efficient. A number of trends will make made it easier but expertise is required to make sure this can be investors pay greater attention to the impact of tax drag on done without falling foul of tax laws. performance. These include the increasing use of passive funds and the growth of auto-enrolment. AMX provides a new route to accessing TTFs By using AMX, the institutional platform, to access tax transparent Removing withholding tax improves returns CCFs, investors and fund managers no longer have to go to the Different European jurisdictions have developed specific hassle of setting up their own management company and fund. structures which can be used to provide a Tax Transparent Fund And it’s now possible for individual pension schemes, as well (TTF). An example of such a TTF is the Irish domiciled Common as multinational firms, to take advantage of Tax Transparent Contractual Fund (CCF). The fund has no legal personality Funds. Tax returns need to be tailored for the jurisdictions of and therefore allows a ‘look through’ to the tax status of the the different investors. AMX can offer trustees peace of mind to underlying investor for the purpose of withholding tax on dividends. ensure tax reclaims are being correctly administered; the platform The advantages of using a global equity fund which minimises provides operational oversight of the tax services provided by the withholding tax can be significant. It can boost the performance administrator through the use of robust technology and expertise. of a fund by as much as 100 basis points and around 30-40bps on average1 , for tax exempt investors such as pension funds. 1 Irish Funds – Common Contractual Funds: The Tax Efficiency in Asset Pooling, June 2015 Using Tax Transparent Funds to improve investment efficiency // Page 3 Using Tax Transparent Funds to improve investment efficiency 1 Pooled funds – a useful tool for institutional investors 5 2 The development and advantages of tax transparent pooled funds 7 3 How do Tax Transparent Funds work? 9 4 Finding tax efficiency for institutional investors 10 5 Why asset managers should consider offering Tax Transparent Funds 11 6 AMX – a new route to accessing TTFs 12 7 Staying ahead – what’s new? 13 8 Contact AMX 14 9 Glossary 15 Using Tax Transparent Funds to improve investment efficiency // Page 4 1 Pooled funds – a useful tool for institutional investors The utility of a pooled fund cannot be overstated. Even the Withholding tax efficiency in the spotlight largest institutional investor, with the scale and expertise Despite the many advantages of pooled fund structures, ensuring needed to manage multiple segregated accounts, uses they have a withholding tax efficient structure often gets forgotten. collective investment schemes. These funds allow them to Yet paying attention to this aspect of investing can boost the access a particular asset class, even if the allocation is small. performance of a fund by as much as 100 basis points and around 30-40bps on average.2 They are often the perfect investment vehicle for smaller pension schemes as fund managers are unlikely to set up a bespoke A number of key trends will make it more important for pension account for an investment of less than £100m-£200m. schemes to consider greater tax efficiency over the medium-term: Another benefit is that these funds require less in-house governance. For example, exercising voting rights and Switch from local to global ensuring assets are correctly valued can be outsourced Pension schemes have become more international in their outlook, to the management company. moving away from UK equity dominated portfolios and diversifying into global equities. But the impact of withholding tax on dividend Some institutions, such as the Local Government Pension Scheme income has not always been well understood. (LGPS), may use these vehicles because they would otherwise have to apply European procurement rules (OJEU). These rules may apply when choosing an investment manager versus In 2017 allocations to UK equities a security in a pooled fund. And, using a collective vehicle can relative to overseas had fallen to 30% help corporate defined benefit plans mitigate VAT payments on “compared to 70% in overseas equities“ manager fees versus segregated mandates. which is a significant change from a decade ago where the allocation stood It also suits investment managers to offer these funds as they are at 51% versus 49%. an effective way to distribute their skill and it is an efficient way to The Investment Association: run a particular investment strategy. Asset Management in the UK 2017-2018, September 2018 Chart 1 UK-managed equities by region (2008-2017) 100% Other 90% 80% Emerging Market 70% Latin America 60% Japan 50% 40% Asia-Pacific (ex Japan) 30% North America 20% European (ex UK) 10% 0% UK 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 Source: The Investment Association, Asset Management in the UK 2017-2018 2 Irish funds – Common Contractual Funds: The Tax Efficiency in Asset Pooling, June 2015 Using Tax Transparent Funds to improve investment efficiency // Page 5 Consolidation of defined benefit (DB) pension funds The industry recognises that running a small multi-million DB fund is not efficient and is looking for ways to consolidate these funds to The Pensions Regulator (TPR) has improve economies of scale. As funds merge, their management repeatedly highlighted the regulatory will focus on aspects such as enhancing governance and “challenge posed by small DB schemes, and minimising the impact of tax drag. consolidation was a key plank of the recent Department for Work and Pensions (DWP) “ DB White Paper and a core recommendation Rising popularity of passive funds from the Pensions and Lifetime Savings The increased popularity of low-cost passive and smart beta funds Association (PLSA) DB Taskforce. makes investors pay greater attention to the performance drag of any charges or fees across all fund holdings. As institutional IPE Magazine, September 2018 investors’ awareness grows, they are reviewing other costs, including the impact of withholding tax on equity performance. Chart 2 Active and passive as proportion of total UK assets under management (2008-2017) 74% of assets are actively managed, down from 83% a decade ago 100% 90% 80% 70% 60% 50% 40% 30% 20% Active 10% 0% Passive 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 Source: The Investment Association Annual Survey, September 2018 The introduction of auto-enrolment Schemes and investment funds therefore need to work with a Defined contribution schemes are now the most important form partner who has the necessary knowledge and robust accounting of occupational pension provision and assets under management systems to make this work smoothly. For example, income needs are growing rapidly. Ensuring scheme members can access distributing on an arising basis to the beneficial investors whilst high-quality yet low-cost pensions is an important policy making sure the source and nature of the income is not changed – principal that has resulted in a management charge cap. this requires accurate tracking and allocation of income to Ensuring employees are not sacrificing performance to individual investor accounts. unnecessary withholding tax will drive companies and master trusts to consider more tax efficient structures. Passive management was more prevalent among equities than fixed income.“ Making a fund tax transparent is a complex process which requires More“ than half of equities were being managed tracking dividend income for managers as well as applying on a passive basis (53%) compared to just over the relevant tax treaties to the right investor. Technological one third of fixed income (34%). developments have made it easier but expertise is still required to make sure this can be done without following foul of tax laws. The Investment Association Annual Survey, September 2018 Using Tax Transparent Funds to improve investment efficiency // Page 6 2 The development and advantages of tax transparent pooled funds The Undertakings for Collective Investment in Transferable Understanding international tax treaties Securities (UCITS) has enabled the liberalisation of the fund The FCP can take advantage of international tax treaties. management industry so products can be sold throughout For example, the double-taxation agreement negotiated with Europe to both institutional, and retail, investors. the US in 1997 allows tax exempt investors, such as UK pension schemes, to pay no withholding tax on US dividends. The UK As UCITS is a directive rather than a regulation, it has led to the has a large treaty network with other investment markets. creation of a plethora of different fund structures developed by Some examples: multiple jurisdictions, which can be sold throughout the European UK pension Union. The acronyms of those structures are familiar to investors: Source country ICAV OEIC fund OEICs were developed by the UK while Luxembourg developed Belgium 15% 10% 0% the SICAV range.