If U.S. mutual funds are going to compete effectively in the international marketplace, a new global fund model needs to be created, according to the fund industry's leading trade group.
U.S.-registered funds based on that model should be taxed like most European mutual funds are, according to the Investment Company Institute of Washington.
Indeed, the introduction of a European fund model in the United States "would make the U.S. regulatory framework for registered funds more compatible with the regulatory framework for funds in other leading jurisdictions around the world," the ICI wrote in a letter to the Senate Republican Capital Markets Task Force on Feb. 25.
Under U.S. tax law, U.S.-registered funds are required to make annual distributions to all shareholders of the funds' income and gains. Many European funds, on the other hand, allow the funds to retain income and gains, and shareholders in those funds don't pay taxes on them until they redeem their shares — allowing for more growth of the assets.
The tax structure essentially discourages foreign investors from investing in U.S.-registered funds, the ICI wrote in the letter.
The push for a global model comes as the U.S. mutual fund industry is losing ground in the bid for global assets.
Global fund assets totaled $26 trillion as of September, according to the ICI.
Of that total, the share represented by U.S.-registered investment companies stood at 46%, down from 66% in early 1999.
Without a change in tax structure, U.S. funds will remain at a disadvantage, said C. Meyrick Payne, a senior partner at Management Practice Inc., a Stamford, Conn., consulting firm for independent fund directors.
"It's by far the largest issue," he said.
SEC WARY
U.S. regulators, however, don't appear to be in a hurry to get behind a new fund model.
"I'd love to have an opportunity" to see how the U.S. fund model would compete against the European model "on a level playing field," Andrew J. "Buddy" Donohue, director of the division of investment management at the Securities and Exchange Commission, said last month at a conference sponsored by the ICI in Phoenix.
The tax challenges that U.S. funds face have been recognized for years.
A May 1992 report by the SEC's division of investment management recommended that the commission "support proposals to eliminate the competitive tax disadvantages for United States investment companies marketing oversees."
That said, such proposals have languished.
While the issue of taxes needs to be resolved, it shouldn't be the deciding factor in whether to adopt a European-style fund structure, said Peter Wallison, co-director of the American Enterprise Institute, a Washington-based think tank.
"If you can have a structure that applies globally rather than just in the U.S., you would have a much more efficient structure for investment management," he said.
Any new fund model would have to include provisions for maintaining a system for the independent review of the fund and its investment manager, the ICI wrote in its letter.
In the United States, that is achieved by appointing independent directors to serve on the fund's board. Outside the United States, however, independent review and monitoring is achieved many different ways, including appointing independent directors to serve on the fund manager's board, designating a fund trustee or giving more authority to fund auditors.
The fact that in the United States, an independent fund board has power over fund pricing gets in the way of market forces that would otherwise drive fund prices down, Mr. Wallison said.
But critics of the European model have pointed out that European funds are on average more expensive than U.S. funds.
The average cost for Class A shares of 1,668 U.S. stock funds last year was 1.3% of assets, Annette Larson, senior research analyst at Morningstar Inc. of Chicago, said in a 2007 interview
(InvestmentNews, April 16).
Although an exact comparison isn't available, she estimated that the average cost for 1,681 stock funds domiciled in the United Kingdom is 1.7% of assets.
E-mail David Hoffman at [email protected].
