Managed investment trusts underpin Australia’s successful funds management industry, but winning the favour of offshore investors will require a new investment structure, writes JP Morgan’s Stephen Coutts.
Australia’s managed funds industry is one of the largest and most sophisticated in the world. However, the trust structure underpinning that success is unusual – at least compared to many other countries across Asia, Europe and North America.
A new type of investment structure promises to change that. Collective investment vehicles (CIVs) wrap Australian funds management expertise in a legal structure that offshore investors know and prefer.
Corporate CIVs (CCIVs) will be introduced for income years starting on or after 1 July 2017 and limited partnership CIVs a year later.
Looking at investment vehicles in other jurisdictions such as SICAVs, the open-ended collective investment scheme common in western Europe, or OEICS, the United Kingdom’s open-ended investment company structure, offer shares (rather than units) and dividends (rather than distributions), and are also open to Australian investors.
The new vehicle will form a critical component of the local industry’s global push, including through the Asia Region Funds Passport, and allow Australia to compete with global funds management centres in Luxembourg, Ireland and the UK.
Bringing Australian expertise to the world
The Australian financial services industry is highly regarded and the skill of local managers is increasingly attracting offshore investors.
Overseas-sourced funds managed by local managers almost doubled to $91.54 billion over the five years ended 2015, according to Australian Bureau of Statistics data.
Asia-Pacific is the largest source according to a Financial Services Council (FSC) survey despite not having common law jurisdictions, with Japan ($11.43 billion) and New Zealand ($5.16 billion) the largest contributors.
However, considerable opportunity remains in other parts of the world where investors are used to a civil law framework rather than Australia’s common law system. For example, flows from Europe ($3.9 billion) and the USA ($2.8 billion) to Australian fund managers represent a tiny proportion of their total assets.
The UK experience highlights the opportunity. The trust structure dominated their funds management industry until the introduction of a similar corporate collective scheme (open-ended investment companies) in the late-1990s.
Today, about 40 per cent of the £5.7 trillion managed in the UK by Investment Association members is from offshore investors.
But removing structural barriers is just one element behind Australia’s global push. It will take manager skill and the ability to target asset classes of interest to offshore investors.
Commercial property and infrastructure are two such areas. Those assets (as well as fixed income and cash) tend to offer relatively higher yields compared to other developed countries where official interest rates remain lower.
Offshore investors have so far also directed significant flows to Australian funds managing global shares and overseas property, demonstrating the skill of local managers, according to the FSC data.
New questions for funds and service providers
Funds focused solely on the domestic market may prefer to move into the Attribution Managed Investment Trust (AMIT) regime, which modernises trust tax law, but CCIVs may offer many of those same benefits while also being more attractive to offshore investors.
CCIVs in other jurisdictions provide another benefit: strict segregation of legal liabilities between investors holding different share classes.
An AMIT offering multiple unit holder classes (such as hedged and unhedged investment options) offers segregated tax liabilities but not legal liabilities if an issue arises.
The underlying structure of CCIVs is likely to be significantly different from managed investment trusts.
Responsible entities play a unique role managing Australian managed investment schemes such as trusts.
They replaced the dual roles of manager and trustee in the late-1990s in an effort to better safeguard assets and bolster investor protection.
This is radically different under European investment vehicle structures, which is managed by a board of directors and a management company.
The management company appoints a depositary, which has a fiduciary obligation to safeguard assets as well as provide a range of other administrative tasks.
This suggests that the responsible entity acting under a managed investment trust structure would need to hand over certain functions to the depositary if the CCIV structure took on a similar approach.
It also raises questions for custodians – which often act as depositaries in overseas markets – and the services they currently provide to managed investment trusts.
It would mean they would have far stronger fiduciary responsibilities if acting as a depositary, which will reshape the risk-liability curve of those custodians acting simply as a safe keeper and administrator of assets.
While the CCIV regime presents a significant opportunity, some uncertainty remains.
Withholding tax applied to foreign investors remains relatively high and complex to administer. The industry awaits the consultation paper from Treasury in order to understand the approach to providing a competitive withholding tax system.
The FSC has proposed a single 5 per cent non-resident withholding tax rate for Australian collective investment vehicles and managed investment trusts. However, these issues are unlikely to be resolved in time.
The collective investment vehicle opportunity is a long-term play for funds focused on offshore markets and attracting foreign investors into a vehicle that is more recognisable to other foreign jurisdictions, but one they should be planning for now.
Stephen Coutts is vice president, senior product manager, unlisted assets and regulatory product, custody and fund services, JP Morgan Australia and New Zealand.