The Best Offshore Funds
What's the hottest investment on Wall Street? Mutual funds, of course. But America isn't the only place where mutual-fund mania is taking hold. Outside the U.S., investors are pouring record sums into funds of their own. And not just any mutual funds. From Hong Kong to Hamburg, the place to be is in the area once reserved for the ultraprivate and mega-rich: offshore funds.
Some offshore funds go back decades. But many more trace their roots back to the 1970s, when investors from around the world began flocking to Bermuda and the Channel Islands off Britain's southern coast. Corporate executives favored these centers because they levied little or no tax on investment income. And many residents of Latin America and the Middle East preferred offshore investing to keep their assets safe from political and economic turmoil in their homelands. Today, minuscule taxes and political security still are among the concerns of offshore investors. But now funds are run out of a growing roster of cities, including Luxembourg and Dublin. And they increasingly cater to doctors, dentists, and other professionals along with their original investor base.
MANY BULLS. Although offshore funds can't be sold in the U.S. because their sponsors don't choose to register them with the Securities & Exchange Commission, they are run by a familiar band of U.S. and global money managers, including Deutsche Bank, Robert Fleming, Fidelity Investments, and Chase Manhattan. They are not short of assets to invest. With an estimated $1 trillion in money-market, bond, and equity assets, offshore funds are every bit as able to move markets as their larger U.S. counterparts.
Of all the fund industry's sectors, the most dynamic is clearly equities. That's no surprise, given the bull market on many stock exchanges in the U.S., Europe, and emerging economies. But how to pick the right fund for you? Let us give you a hand. Working with data compiled by Micropal Ltd., a mutual-fund research organization in London, BUSINESS WEEK has assembled an exclusive Scoreboard on the world's 500 largest offshore equity funds.
Our Scoreboard fills a growing need. While American investors are flooded by information on mutual funds, offshore fund investing remains a hit-or-miss affair. More often than not, investors buy whatever local bankers or financial planners have to offer. To shop more widely, you need better information. But data on even the largest funds have been hard to come by and interpret.
Until now, that is. Building on 11 years of experience with Scoreboards on U.S.-based mutual funds, BUSINESS WEEK gives you a wealth of detail unavailable anywhere else. What's more, we put all the information together to give you the key information you need to make educated choices: risk-adjusted ratings.
At BUSINESS WEEK, it's not enough for a fund to get the highest returns. It must earn these returns after adjusting for the risk its managers took with your money. Our bottom line on risk is whether you'd have been better off keeping your money in U.S. Treasury bills, the most widely accepted standard for riskless investing around the globe. We then gauge how well each fund performed relative to the Financial Times/Standard & Poor's Actuaries World Index. And we don't award ratings to hot newcomers. We rate a fund only after it has built a five-year track record--long enough to see how it performs in a variety of market conditions. In the 12 months ended Sept. 30, only 21 out of 500 funds merited our highest rating: three upward-pointing arrows.
Of course, you will probably want to factor in other considerations as well. So we rank funds' total returns over the past year, in which U.S., Eastern Europe, and Russia funds have stood out. We compare the one-year performance of each of the 500 funds to others that invest in the same geographic areas, and look at what funds earned over three and five years.
But performance isn't everything. We peer inside portfolios to reveal funds' largest holdings and the amount of cash--or leverage--they have on their books. And we include the latest available figures on management fees, plus sales and other charges. Fees can be sky-high in the offshore business, where regulators often have a more laissez-faire attitude than do their counterparts at America's SEC. Sometimes even fund sponsors won't disclose all their charges to individual investors without a struggle. High overhead costs, of course, can make all the difference between a solid performer and an also-ran.
To help you build a portfolio of high-rated funds, we also asked four investment pros to come up with strategies for asset allocation (box), ranging from conservative to quite aggressive. Taking their advice and the Scoreboard together will allow you to stick with more highly rated funds while steering clear of high-volatility entries that have underperformed their peers.
NO PEAK? Fortunately, there are highly rated funds that cover many of the world's best markets. Do you think U.S. stocks still haven't peaked? Check out the Fleming Flagship Funds American and JF American Growth, two essentially identical big-cap funds sold in Europe and Asia, respectively. Related funds that are sold in different geographic areas are common among money-management groups that like to tailor marketing pitches and fee structures to local tastes. Managed by Jonathan Simon of Fleming Capital Management in New York, each fund has tallied a tidy average annual return of 23% over the five-year period ending Sept. 30. Or perhaps biotechnology is your idea of the industry of the future. GT Healthcare B, the offshore clone of LGT Asset Management's U.S. health-care fund, might be just the ticket. Betting on companies developing new AIDS remedies and other drugs has enabled manager Michael Yellen to notch a 27%-a-year average growth rate.
Maybe you want to put some of your money into the fast-growing economies of Asia. Among the top-rated funds is Invesco ASEAN Development, up 31% a year. Or your taste might run toward buying companies on the cheap. If so, have a look at Regent Undervalued Assets. A global bargain-hunter run in London by Regent Kingpin Capital Management Ltd., it has recorded a 19%-a-year growth rate since 1991.
As a list of equity funds, the Scoreboard does not include most hedge and "macro" vehicles, such as the Quantum Fund run by superinvestor George Soros. These funds invest in debt and derivatives as well as equities, often use large amounts of leverage, cater to a small, upper-bracket clientele, and exist in a class of their own. What the Scoreboard does do for you, however, is to put all 500 funds on a common standard by converting the results of nondollar-denominated funds into U.S. currency. That penalizes some funds investing in countries whose currencies have weakened lately. Indeed, among the worst-rated funds are several that target Japan, where the yen has fallen sharply and the stock market has gyrated wildly.
The past swings are reason enough to view Japanese funds with caution. But the world's second-largest economy still has its advocates, among them Mark Richardson, chief investment officer for the Chase Manhattan Vista funds. Although many global investors have abandoned Japan recently, fearful of the country's shaky economic recovery, Richardson thinks domestic buyers will soon take their place. He argues that Japanese fund managers will resume buying stocks to prop up the abysmally low returns on their investment portfolios. But other money mavens would rather stick to the U.S.
Fleming's Simon, for one, is buying shares of Kimco Realty Corp. for his funds, which invest mainly in American stocks. A real estate investment trust that runs strip shopping centers in the Midwest and Florida, Kimco sports a comfortable 5.8% yield. Betting that a U.S. economic slowdown will cut raw materials costs, he is also piling up "boring old newspaper stocks" such as Gannett that will benefit from falling newsprint prices. John D. Laupheimer, manager of the MFS International U.S. Equity Fund, is another American bull. Among his favorites are ITT Hartford and Allstate, whose price-earnings ratios of 10 are little more than half the market average. He also favors Philip Morris, despite new studies linking cigarette smoking to lung cancer. Philip Morris' "phenomenal cash flow and earnings," he argues, will leave it "in a position to fight tooth and nail as long as it takes" against legal moves to stick cigarette producers with the bill for smoking-related deaths.
Some managers firmly believe that lesser-known American companies also deserve a place in any offshore portfolio. And most investment advisers believe that emerging markets--the turnaround economies of Latin America, Asia, Africa, and the former communist bloc--also should play a role in any long-range investment strategy.
In fact, Jurg M. Lattmann, a financial planner based in Zug, Switzerland, recommends allocating at least 10% of your portfolio to a diversified vehicle such as the Luxembourg-based Credis Equity Emerging Markets Fund. He thinks such a fund could return 12% annually over the next two decades, three percentage points better than a fund composed of industrialized-country blue chips. But for those who want to invest region by region, many Asian-oriented funds have won top ratings in this year's Scoreboard. And some of the newest up-and-comers worth watching are a gaggle of funds investing in the economies of Russia and Eastern Europe.
It's too soon to say whether the area's volatile markets will sustain this year's gains. But specialists anticipate a continued bull run in Eastern Europe, despite frequent steps in the wrong direction. For example, the Polish market declined 5% in one week in October alone. Nonetheless, Henk Vaandrager, fund manager for AAF Eastern Europe Equity Fund, which posted a 59% return over the past 12 months, notes that manufacturers in Eastern Europe who can produce top-quality goods 30% more cheaply than competitors in Western Europe make a super long-term growth story.
But long-term growth is only one of the factors you should consider as you build your fund portfolio. Equally important is a fund's investor-friendliness: how much it discloses about its holdings, how high its fees are, and its trading patterns. On these criteria, many offshore funds don't measure up to their counterparts in the U.S. "By and large, offshore funds do not disclose their expenses and costs in a way that even we can understand--much less the ordinary investor," acknowledges Micropal Chairman Christopher Poll.
TRUST ME. How come? For one thing, because offshore funds aren't sold in the U.S., they don't have to file the exhaustive reports with the SEC that their American counterparts have to produce. Add to that the offshore industry's penchant for secrecy. But this is exactly what many offshore fund investors say they desire.
Unlike the U.S., where funds report their customers' income and capital gains directly to the Internal Revenue Service, offshore fund havens do not require managers to report customers' income to anyone. The funds rely instead on the willingness of investors to comply with local tax laws. This is why Luxembourg has become such a prominent fund center. Most of its business comes from institutions such as Deutsche or Generale de Banque, which sell their own offshore funds to customers back home in Germany or Belgium, where taxes are sky-high. It's much the same in Switzerland, where perhaps 70% of all mutual-fund assets are held by nonresidents who would just as soon keep information on their finances between themselves and their bankers. But no matter where they are based, "you'll never see an offshore fund producing a tax return for an investor," concedes the head of a major bank's fund group. "The whole industry is based on trying to make sure investors who want to avoid taxes can do so."
In this climate of discretion, it's hardly surprising that some funds still are wary of publicly disclosing more than rudimentary information about their fees and investing activities. A lack of competition doesn't help, either. The U.S. mutual-fund industry's growth has been fueled by billions of dollars pouring into tax-deferred retirement plans. It now features thousands of funds using toll-free phone numbers, the Internet, and the marketing savvy of Charles Schwab, Merrill Lynch, and other big brokers to get their messages across to investors. Offshore managers, however, market their wares across numerous national borders and have built up nothing like the huge funds of the U.S. While America's largest mutual fund, Fidelity Magellan, has $53 billion in assets, the largest offshore fund, Netherlands-based Robeco, is a $6 billion stripling.
Some industry critics contend that the lack of available information made it easier for rogue fund managers at Jardine Fleming Securities in Hong Kong and at Deutsche Morgan Grenfell, Deutsche Bank's London investment banking unit, to get away with running huge irregularities in their accounts before being snared in scandals over the summer. Had the managers been obliged to report more fully to investors, alarms might have gone off earlier.
The lack of competition and disclosure--and the tax advantages of offshore funds--also allow them to charge higher fees than their U.S. cousins. Peter Jeffreys, managing director of London's Fund Research Ltd., estimates that the average Luxembourg-based offshore fund has an overall expense ratio of 2%, nearly double the average for funds in the U.S. That's only a rough guess. Offshore funds typically report part of this ratio--the amount that goes for management--in their brochures. But there are other fees that may not be as readily disclosed. There are charges to switch among funds, custodial fees--what management companies pay banks to hold their securities--and performance bonuses for successful managers. These bonuses may be defined by algebraic formulas that, some managers say, are designed to leave investors in the dark.
"NOT FAIR." You might be able to find some of the extra charges by poring over fine print in annual reports. But others remain buried in the funds' books, especially among funds marketed by some Swiss banks, which rivals say are among the biggest offenders. The result is that true expense ratios are still tough to gauge. "A manager might list a fee of 0.75%," says an executive at Citibank, which has an offshore fund family of its own. "Then you go to the annual report, and you find you're really being charged 3%."
With extra fees so easy to collect, it's no wonder that one manager for a large U.S. insurance company says profit margins on his offshore funds are 20% greater than those on the funds he manages that are based in the U.S. Fortunately for investors, things are starting to change. Rupert Rucker, who runs offshore funds specializing in Russia and Ukraine at London's Fleming Investment Management, notes that he cut his management fee from 2% to 1.5% last month. He also scrapped a performance fee that was to have kicked in whenever the funds' net asset value increased by 20% over of two years. Not only had he not achieved this goal but market pressure to eliminate such bonuses is growing. "Performance fees are not fair," Rucker says. "If an investor buys into a fund, he should know what the fees are going to be."
Several U.S.-based fund-management groups say they already adhere to this straightforward approach. Managers at Citi and Chase for example, insist that they follow U.S.-style disclosure in their offshore funds, even if this makes it appear their expense ratios are higher than their competitors. Agrees Paul Dunning, president of Safra Republic Investments (U.K.) Ltd., which plans to have a new family of 22 offshore funds on the market by the end of the year: "We're making our standards akin to those in the U.S. as best as we can."
Dunning and many rivals also say more funds are gravitating toward the European Union fund-management centers of Luxembourg and Dublin because regulators are requiring more investor-friendly behavior. This could not come at a better moment. Some fund executives think it's only a matter of time before the offshore industry experiences the same sort of growth seen in the U.S. With populations aging and state pension systems already overburdened across the industrial world, consumers are starting to get more serious about building retirement nest eggs of their own through funds.
If consumers around the globe are going to depend more on mutual funds for their savings, they will need to become better educated in the ways of the investment world. One way is through better scrutiny of funds. BUSINESS WEEK's Scoreboard can't guarantee that you'll always make money. But it will certainly allow you to manage your money from an informed perspective.