When starting a hedge fund, determining in which country to launch the new fund is among the highest priorities of a manager. The decision of where to domicile the new fund can have a huge impact on the type of investors that will be attracted, associated costs, regulatory governance, speed of the launch, strategies that can be implemented, issues of taxation and treatment, and countless other considerations.
Fortunately, the options run aplenty and stretch well beyond the market in which the manager resides. Determining which domicile best suits a new fund boils down to understanding and focusing on several key considerations.
In the business of running money, prospective new fund managers generally enter the arena having already tested and achieved results with a strategy or differentiating approach that they plan to implement within their new fund. With the decision of their approach defined, they are able to address two of the most important considerations for any manager – that of profiling and identifying their ideal investors and determining where to establish their fund… major issues that are interrelated.
Know Thy Investors
Before making decisions regarding the investor groups they will market to and where to domicile, fund managers must first engage in due diligence, as those decisions are predicated foremost on understanding the needs of targeted investors. “A fund promoter should have a clear marketing strategy for the fund,” offers Robert Hennessy, senior consultant with KB Associates, a firm specializing in offshore fund consulting. “The primary consideration will be the target investor’s requirement/preference. It must be determined if there is investor appetite for a less regulated fund, e.g. a Cayman Islands fund – the traditional domicile for hedge funds, or a more regulated European domicile such as Ireland or Luxembourg.”
Part of the overall process for a new manager is becoming familiar with the various guidelines and restrictions that investor groups are oftentimes governed by when making investment decisions. “Many institutions will have a restriction on allocation to alternative funds and a further restriction which requires investment in regulated products,” say Hennessy. “There may be restrictions on the allocations which target investors can make – e.g. investment may be limited to funds domiciled in regulated jurisdictions…. You need to understand your target market and which jurisdictions are acceptable to those investors. Therefore you need to ensure that your chosen jurisdiction will be recognized in the home countries of the target investors.”
Regardless of where a fund is established, the cost to launch and operate is a major consideration for managers and investors alike, as it directly affects performance. Minimizing costs and maintaining the total expense ratios (TERs) at the lowest possible level is critical given the direct impact on alpha, according to Hennessy. As such, the decision on where to launch is highly relevant due to the regulatory expenses inherent to each jurisdiction considered. “More expensive jurisdictions will mean increased running costs and therefore higher TERs,” he cautions. “Generally, the less regulated jurisdictions will be cheaper. This is due to lower minimum capital requirements and lower legal/regulatory fees. Greater regulation will invariably lead to higher costs – therefore the cost of launching and operating a fund in the European centres (of) Ireland/Luxembourg will be higher than similar costs for the Cayman Islands.”
Speed to Launch
The amount of time necessary to address a given jurisdiction’s requirements regarding fund establishment is another consideration for a manager, as it affects the timing of the fund’s launch. According to Hennessy, it can take less time to launch in lesser-regulated jurisdictions, but even the more-regulated markets are taking steps allowing for quick approval. “The more regulated jurisdictions have also introduced more streamlined, fast-track procedures for fund approvals,” he says “For example, in Ireland, the Qualifying Investor Fund (QIF) can be approved within 48 hours following submission of the required documentation to the Central Bank of Ireland.”
While tax treatment is of importance to a fund and its investors, it plays less a role in determining where best to launch a new fund. “The main fund domiciles already have the necessary tax legislation in place to facilitate tax-efficient fund structures. Generally, the fund itself will not be subject to tax and this would be a common feature across the main jurisdictions,” notes Hennessy.
That said, new managers need to recognize that there are variances in treatment and benefits amongst potential domiciles. “Certain jurisdictions will enable funds to access double tax treaties which can give the advantage of reduced rates of withholding tax on dividend payments or interest,” he says.
The strategy to be deployed in a new hedge fund is a differentiating factor and of critical import to the manager, so determining that such an investment approach can be fully implemented in a particular domicile is important. In general, lesser-regulated markets tend to offer more flexibility in terms of investment strategy/fund products than those more regulated, according to Hennessy. Additionally, there are domiciles that tend to be more favorable overall to specific types of funds. “Certain jurisdictions have established themselves as the leaders for particular fund types – e.g. private equity fund promoters will generally choose Jersey in the Channel Islands,” he says.
While there are many elements that weigh into the decision of where to domicile, Hennessy makes it clear that the needs of the targeted investor group trump all others. “In choosing the best country to launch a fund, the two most important factors, as mentioned earlier, are investor preference/requirements and cost. Given the increased amount of regulation such as Dodd-Frank, Alternative Investment Fund Manager’s Directive (AIFMD), UCITS V and VI – it is investor preference rather than cost which has become the critical factor,” he says.
Ultimately, a new fund manager must assess the requirements of the investors that will be targeted, factored with those of the fund and its approach, to make the determination as to which jurisdiction best meets the criteria. In so doing, a new fund manager can easily come to the right decision on where to launch a new hedge fund.