Although the popularity of alternative investments is on the rise across Europe, many restrictions still exist which serve as barriers to investing. These are predominantly tax and regulatory issues initially established to protect investors from associated risks.
The problem lies in the mosaic of Europe’s tax regime, which means each country has its own version of the ideal alternative investment vehicles. The German market has the most restrictions in place, despite its status as third largest alternative market in Europe after the UK and France.
Says Jan Faber, head of global private equity fund investments at Henderson Private Capital: “The German market is still not living up to its promises on domestic investing in private equity.”
In Germany, the foreign investment act was originally established to protect retail investors from investing into foreign entities and set up a prohibitive tax of 90% on investments in foreign equities, but it is not yet clear whether it applies to private equity investments.
Bernd Kreuter, director of private equity, Feri Alternative Assets, says: “The rules apply to investors that are taxable in Germany and want to invest outside the country in any country, even within the EU. So they are deterred from investing outside Germany. To manage the risk, we never invest in a non-German fund. If we want to invest in a US limited partnership, we require a German parallel fund that invests pro rata or in parallel.”
Jeff Ganung, director of alternative investments at Frank Russell, says: “It is just one more barrier to private equity investing, and if we see more of these negative tax changes, the government will discourage good investment behaviour. This type of situation drives people to create complicated structures and to start wrapping private equity investments in various guises to get around the local regulations that might prevent them from marketing the fund itself. This is counter-productive because you wind up with more cost.”
Ganung adds: “The approach we are taking is to partner with local institutions to create a parallel fund structure. We were prepared to put the time and effort to set up a relationship with a partner to create a fund structure that is tailored towards the local market and meets both tax and regulatory requirements. But we also decided to go ahead and tweak the investment content as well to create a product more oriented to local investors’ needs.”
Henderson Private Capital has chosen the same route by partnering with Feri Alternative Assets to create a structure that invests in local parallel funds of international funds. Faber says: “We have set up a local vehicle for each fund, which will then invest directly into the underlying companies along with the US fund. It is very cumbersome but it is the only way to avoid tax issues and concerns of being classified as a black fund.”
Another solution to overcome restrictions is to set up a feeder structure, which is a German limited partnership that invests into US limited partnerships, but it has been criticised as the intermediate structure is transparent and hence is not safe for tax purposes.
Bruno Raschle, managing director at Adveq, claims it is not difficult to come up with a solution and that simplicity and flexibility remain key. “German institutional investors can invest into the US through our main fund of funds. Today there are solutions when you stipulate that you are in a trade of business and you then make use of reimbursement schemes, so that most investors can reclaim or get 100% credit for the tax they have paid. Then it becomes very simple and we do not need parallel structures when investing in the US.”
He adds: “It is a cultural issue when you address the challenges. What we do is manage the lawyers and we don’t let them manage us. We have been able to set up a structure that costs 0.1% of the whole committed capital, so it is very cheap. The criteria we have set in the beginning was that we don’t want to take risks, it has to be simple and we must have intrinsically built in lots of flexibility to absorb changes that might happen in the future.”
Another country almost on par with Germany in terms of restrictions is Denmark where the market has manifested similar caution towards alternative investments and is no surprise that alternative investments here constitute less than 1%.
Jorgen Leschly, head of funds and investment at Willis Denmark, a Danish benefit consultant offering manager selection for the DC market, says: “Our pension plans have been around 70% bond oriented for a long time, so we don’t have an equity culture. Some of the larger funds have tried to invest in private equity and hedge funds but have lost money on local Danish ventures. So this concept is difficult from the outset.”
But unlike Germany, dual standards are practised in Denmark, where the investor must take full investment responsibility otherwise the legislation prevents the manager from investing in hedge funds and private equity. All they need do is shift from a compulsory DC scheme where they have a guarantee into a unit-linked scheme where they are allowed to do what they want, but must then bear all the risk.
Leschly adds: “We try to convince our clients that they should shift from the traditional schemes into the unit linked schemes. Then they will have got round these rules and regulations and can do whatever they want. But there is no market for it yet.”
In Italy, where selling any kind of foreign fund is heavily restricted and requires approval by the Italian regulators, different restrictions apply. It is much easier to sell investment services than investment products that are not Italian. Hedge funds, for example, are required to be locally registered and the central bank’s regulations state that only an Italian bank can be custodian to an Italian hedge fund.
However, the rules now permit domestic banks to give all or a portion of the fund’s assets to a sub-custodian. Banca d’Italia recently authorised the operation of the first single-strategy hedge fund in Italy to be managed by the Milan-based e1.6bn fund manager, Gruppo Kairos.
Sara Pantarotto, product manager of alternative investments at Intesa BCI, custodian of the Kairos hedge fund, says: “The only limitation is for Italian investors because the hedge fund has got a minimum subscription level of e1m so it is off limits to the retail market. This was decided by the Italian regulators as they believe that investing in hedge funds is risky and the retail investors are not experienced enough, But it is already a first step to have launched a pure hedge fund in Italy and we are positive for the future.”
Tycho Sneyers, head of business development at LGT Capital Partners, an alternative asset fund manager with over e2.9bn assets under management, argues that one solution to overcome restrictions across Europe, is to invest in an exchange traded private equity fund or fund of funds, whereby an investor can buy and sell the shares on a daily basis.
He says: “If investors can only invest in listed or liquid assets, an exchange-traded private equity fund of funds allows them to comply with their rules and gain exposure to the private equity asset class at the same time.” LGT manages assets for two such investment companies listed on the Swiss Stock Exchange.
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