What is an investment fund?

What is an investment fund?
What is an investment fund?

The investment fund (or IF) is a financial entity that makes collective investments for the purpose of extracting the maximum benefit from working as a group.

It is precisely for this reason that the idea of registering an investment fund (IF) is rapidly gaining currency among investors.

The advantages of setting up a private investment fund are as follows:

  • involvement of professional managers who can ensure high profits and effective risk management;
  • reduced transaction costs;
  • increased asset diversification to reduce unsystematic risks;
  • ability to attract funds from third-party investors (with certain restrictions).

Other benefits include:

  1. The fund can make a contribution not only to one industry (e.g. construction or IT) but also to several different and sometimes unrelated (mixed) industries.
  2. Fund assets consist of units. Initially, shareholders-investors invest money/assets by buying units; after that, they receive profit according to the share invested in the total investment volume.

If you are interested in creating your own fund, we recommend that you consider opening a charitable foundation.

Types of Private Investment Funds

Funds are divided according to different criteria. The most popular (though riskier) of them are mutual funds, hedge funds and ETF funds.

If you are intended in opening your own investment fund, please note that there are two main types of such structures:

  • open-end fund in which shares can be bought freely and at any time;
  • closed-end fund in which shares are acquired exclusively at the time of their creation and are sold freely.

The structure of an investment fund created in different jurisdictions is pretty much similar. For example, if you decide to register an investment fund in Switzerland, it will have the same basic features as the one established in Latvia (hence. the requirements you will have to comply with to open an investment fund in Latvia will be almost identical to those in Switzerland).

Another criteria according to which IFs are categorized is the place of registration. Speaking metaphorically, this is a kind of “peg” to which your fund is ‘tied’ in a specific jurisdiction and where managers of the fund are located.

The worldwide trend today is the unification of investment fund parameters. In terms of procedure and requirements, opening an investment fund in Cyprus is almost identical to registering an investment fund in Liechtenstein.

Please note that the above jurisdictions provide the most legal protection for the creation of such financial institutions.

Whatever official name your investment fund has in any country in the world (these names may differ), its essence (i.e. organizational structure) remains the same: it will always be an IF.

The structure of an IF:

  • an owner or promoter of an investment fund (founder/group of founders) who, unlike investors, is capable of influencing a fund’s policy;
  • Investors/"shareholders" who have invested money in fund management;
  • a legal entity responsible for document management;
  • stock brokers;
  • a fund can be controlled by a management company (or local/your own) manager. The presence of a manager may be necessary if, for example, you open an offshore investment fund. In this case, you will need to obtain a license for this manager, because it is the manager who is often responsible to investors in tax-free zones;
  • a fund’s accounting reports and records in the register of assets (shares/securities) are maintained by a depositary/custodian that can be either a bank or licensed legal entity;
  • a registrar - an organization that carries out the necessary transactions with a fund’s stocks.

What is a Mutual Fund?

The mutual fund is the most popular type of IFs. It does not have a legal entity status; hence, the right to dispose of all its assets belongs to the same management company. Operation of such a company is controlled and regulated by the owner of the fund and relevant financial regulator.

The main stages of opening a mutual fund are as follows:

  1. To adhere to management principles and rules;
  2. To find investors willing to establish a fund (they are also the ones who will own shares in your IF);
  3. To determine who will act as a management company: a hired legal entity or one created independently;
  4. To register a fund (optional);
  5. To choose a depository with whom shareholders will place their assets. The main task of a depository is to monitor the legality of all transactions carried out with a fund’s assets.

You can register a mutual fund for the following purposes:

  • fundraising;
  • providing the maximum security (legal guarantees) for investors and their assets through the legal structure of a mutual fund;
  • tax minimization/tax savings;
  • incorporation of the fund in a particular business.

The benefits that the owner or beneficiary of the fund gets are as follows:

  • implementation of large-scale financial projects. Having an understanding of how to open an IF will enable you to make use of an instrument referred to as collective investment;
  • increased attractiveness of the fund as a financial instrument (‘packing’ your project in an IF ‘shell’);
  • reduced distance between financial resources and owners of the fund. If you offer a competitive and effective investment program or idea, it is much easier for you to interest a group of investors (fundraising).

The advantages of setting up a mutual fund include:

  • A mutual fund is a powerful mechanism for building legal relations with investors. Their confidence in the assets’ safety based on the legislation of the country of registration and its financial institutions that control the fund’s activities;
  • Asset protection. Each commercial activity of the fund will be overseen by a guarantor (a depositary). In addition, investors/shareholders will have the opportunity to coordinate all transactions with the fund’s assets before their implementation;
  • Tax savings. Closed-end mutual funds are often created for the purpose of cutting taxes, especially in the field of real estate. If the assets remain within the fund, profits from any operations with them are not taxable;
  • Confidentiality. Regardless of jurisdiction, the list of shareholders/investors is not the list of founders. That is, this information is not public. Thus, you do not need to spend money on hiding your participation in the project as a beneficiary.

The hedge fund (a protected fund) is one of the types of collective investment activity. It can be called a partnership made up of the so-called main fund (acting as the main manager) and investors (individuals contributing money).

Hedge funds are created to maximize investors’ profits and eliminate possible risks. By purchasing unpopular securities/securities, revaluing them and reselling them at a higher price, the hedge fund makes money regardless of market fluctuations.

We recommend that you register a hedge fund in Malta– a jurisdiction with highly advantageous conditions for conducting international business.

Differences Between Mutual Funds and Hedge Funds

Parameters

Mutual Funds

Hedge Funds

Securities

Standard: stocks, bonds etc.

All the same + goods, options and so on + short sales (an opportunity to earn during a slump in the market)

Payment for manager services

Depends on % of managed assets

(no hard incentive)

Depends on the real profit of the fund

(with a hard incentive)

Availability of manager's shares

Impossible

Possible

Methods and instruments

Standard (strict management)

Flexible (manoeuvring, a wide range of strategies)

There are 3 categories of hedge funds:

  • funds managing assets of companies on a global basis;
  • funds operating on stock exchanges and using reevaluated company assets;
  • funds operating in certain countries and using data on domestic economic policy.

If you would like to open a hedge fund, you should keep in mind one thing: investing in hedge funds entails more risks, even though large hedge funds have existed for more than thirty years and continue to earn money.

What is an ETF Fund?

Exchange Traded Funds (ETFs) are funds operating with equity indices (i.e. index ones) or precious raw materials (raw materials).

Unlike mutual funds, ETF funds are more profitable (by some 0.8% per year). Because mutual funds require ‘proactive’ management, their investors must buy shares or invest in trust management. And in the case of a passively managed ETF, a unit can simply be purchased on the exchange and with a minimum commission.

Because of the risks associated with the creation of an ETF fund, we will not discuss their establishment.

By contrast, the “standard” (managed) IF, even when it is an industry-specific one, has shares from different market sectors. So, it is more diversified.

Summing up, we should take a closer look at manageable investment options. Today, there is no tendency toward expanding the popularity of “passive” investments. On the contrary, the most attractive option nowadays is cost minimization.

How to Open an International Investment Fund?

Setting up a private IF will require one to carefully analyze financial indices, competitive environment, marketing costs and implementation methods.

Obtaining a license of an investment fund can be a long and complex process. If you still want to register an IF, our company can help you with that.

If you would like to obtain a license, you will have to

  • register a management company (open or closed joint-stock community, etc);
  • provide a copy of the balance sheet;
  • provide financial statements (profit or loss statements of the company);
  • provide information on an annual audit;
  • provide receipts confirming the payment of all fees;
  • submit an application for a license;
  • provide a copy of the Charter (Memorandum of Association);
  • provide documents confirming experience and qualifications of the fund’s employees.

For more information, please consider contacting YB Case.

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