“Could you discuss offshore funds? I am an ‘ordinary’ investor, never invested in offshore funds, wouldn’t know how to do it, not sure that it’s ‘legal.’ Please don’t use my name.”

To an American, offshore is anything outside the U.S. To a Russian, offshore means anything outside Russia. Technically, Canada would be off our shore and Latvia off Russia’s, but some of these things do seem to be based on tax-friendly Islands. The Bahamas. Cyprus.

An offshore fund (to an American) is one that U.S. law prohibits being bought by or sold to Americans.

If the fund is run by American citizens, they are subject to U.S. laws on insider trading, taxes, the Foreign Corrupt Practices Act and so forth. But it is exempt from the Investment Company Act. That’s a law which severely restricts the ability of funds to sell short or to make big undiversified bets — betting half the fund’s assets on the collapse of some foreign currency, say. Offshore fund shareholders are not subject to U.S. taxation (though their American fund managers are).

Some Americans do invest in offshore funds, but they must perjure themselves to do so. Many use foreign trusts, with non-U.S. in-laws or non-U.S. institutions as administrators.

Perhaps the most famous offshore funds are George Soros’s Quantum funds. I’m told they were started as such because only foreigners would back him in his early days. In order to protect his original investors, Soros — an American and the world’s leading philanthropist — has kept the funds offshore. (His one attempt to do otherwise, Quantum Realty, was given assurances “at high levels” that its non-U.S. investors would be exempt from U.S. taxes. Politics then demanded this decision be reversed after the fund had been operating for over a year. It had to be disbanded to protect the non-U.S. investors.)

Should we feel rotten these are not just offshore but off-limits? Well, maybe a little but not much.

  • The tax part of it is simple: all good American citizens pay their taxes. Those who outright cheat (municipal bonds and tax-sheltered retirement plans are anything but cheating) are just stealing from the rest of us. I know one wealthy businessman with a few million bucks hidden in foreign accounts. If Uncle Sam ever catches him, he could go to jail. But he likes having this separate stash the government doesn’t know about, appreciating tax-free, and long since seems to have stopped feeling guilty about it.
  • The “foreign” part is also simple: There are lots of ways to invest abroad — mutual funds and New-York-Stock-Exchange listed stocks and ADRs (American Depository Receipts) prime among them. The “offshoreness” of an offshore fund comes not from where your money is invested — it may wind up heavily invested in U.S. stocks — but from the fund’s being exempt from the Investment Company Act and U.S. taxes.
  • Even the short-selling and big-bets part is simple: You don’t need an offshore fund to take a crazy risk. You can do it all by yourself. Right now it’s legal for you to put everything you own into a short-sale bet against just a single stock or foreign currency. A good broker will “know its customer” and restrict you if you haven’t signed lots of forms attesting to your experience and tolerance for loss. But basically, you can do lots of crazy things all by yourself.
  • What does chafe is not having access to George Soros’s brain. But it’s not U.S. law that will be your obstacle in this so much as the minimum chip he and other star hedge fund managers — both onshore and offshore — require. There are some baby hedge fund managers who might accept $250,000 or even $100,000. But many accept money in $1 million or $5 million or $25 million chunks. So most of us couldn’t hop on anyway.
  • Just because a fund is offshore or called a “hedge fund” (restricted in the U.S. to wealthy “accredited” investors and allowed to take more risk than general public funds) doesn’t assure superior results. Typically, hedge funds charge “one or two and twenty” — 1% or 2% of your assets each year, plus 20% of any profit. Many have had spectacular years even after those fees, but there’s no guarantee that you won’t lose a real bundle in a bad year.

Tomorrow: Back-To-School Car Pooling: Keep A Third Car?

 

 

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