PRINT THIS PAGE Mutual funds to invest in private equity funds?18/06/2008. Source: Borenius & Kemppinen. Paulus Hidén
Certain amendments have been proposed to the Finnish Mutual Funds Act and the Investment Firms Act. The changes would more clearly enable a special mutual fund (a Finnish non-UCITS fund) to invest in closed-end funds. Following the changes to the laws, a mutual fund could in principle be used as a feeder fund or as an evergreen fund of funds. There are, however, a number of restrictions which would be need to be considered, and the use of mutual funds as a new type of a fund-raising vehicle will also depend on what kind of mutual fund rules the Finnish Financial Supervision Authority is willing to approve, writes Paulus Hidén of Finnish law firm Borenius & Kemppinen. Different types of common funds and the concept of financial instrument
The Finnish Mutual Funds Act (MFA) distinguishes so called ordinary mutual funds (UCITS) and special mutual funds. Briefly put, a special mutual fund may in its investment activities deviate from a number of rules applicable to other mutual funds. This enables a mutual fund management company to develop more diversified fund products. As the approval of the Finnish Financial Supervision Authority (FFSA) is required for the rules of any mutual fund, it will also depend on the FFSA what kind of funds the market will see.
Even though special mutual funds may deviate from certain provisions in the MFA, also the special mutual funds are required to mainly in financial instruments (or nowadays also in real estate and real estate securities). The definition of a "financial instrument" includes also units in "foreign mutual funds and a corresponding foreign undertakings engaged in collective investment". Based on the current law it is not clear to what extent a special mutual fund may for example invest in Finnish funds organised as limited partnerships.
Proposed amendments
Certain amendments to the MFA are expected to enter into force during year 2008 (Finnish Government bill 16/2008). The proposed amendments include a revision of the concept of "financial instrument" which would then also include "units and money market instruments of other undertakings for collective investments which are not to be onsidered as securities under the Securities Markets Act". According to
the bill, this is intended to refer, in addition to units of UCITS, also to "shares of Finnish undertakings carrying on collective investments, such as private equity funds and real estate funds formed as limited partnerships".
As a mutual fund is required to invest its assets mainly in financial instruments, the aforementioned should mean that in principle a mutual fund could focus on private equity funds. However, at the same time more precise rules are proposed to be set on what types of financial instruments a regular mutual fund may invest in. As regards investments in closed-end investment funds, there will be certain preconditions with regard to liquidity, marketability, investors' protection as well as in relation to valuation. A typical private equity fund may be unlikely to fulfil these criteria. In practice, a mutual fund making investments in private equity funds should consequently be a special investment fund which may deviate from the rules applicable to mutual funds in general.
Exceptions from the basic principles of the MFA
According to chapter 12 of the MFA, the rules of a special mutual fund may deviate from certain basic rules of the law. If the strategy of a special mutual fund would be to invest primarily in close-ended funds, the illiquidity of the target funds would make it necessary to deviate at least from the rules regarding diversification, valuation and issuing and redemption of fund units.
According to the MFA, a mutual fund management company is required to issue units in any of its mutual funds upon request. The rules of a special mutual fund may provide for an exception in this regard. That could be useful or even necessary, as it would not be reasonable to increase the size of a mutual fund over the amount that it could invest in target funds in accordance with its strategy. An excessive fund size could force the fund to allocate the main part of its investments outside its primary investment strategy if appropriate target funds would not be available.
Similarly, a management company is required to redeem mutual fund units on request. Redemption requires liquid assets, and a special mutual fund investing in closed-end funds might not have liquid assets at hand. Therefore such a mutual fund would most likely need some kind of special rules, making it not as open-ended as most mutual funds.
A likely starting point could be a model where the fund with at specified times "opens" for new subscriptions and redemptions of units. One topic of discussion has also been whether the redemption would be necessary at all if the fund units were publicly traded (and where the investors could exit their investment by selling their fund units on the market).
The MFA also requires the value of a fund to be calculated on each banking day. Special mutual funds may also exempted from this requirement. There is naturally a need for valuation when new units are issued and when units are redeemed, but otherwise a continuous valuation would probably not add much value (other than in relation to a liquid part of the fund's portfolio).
Also a special mutual fund is required to diversify its portfolio. The diversification requirement may be relevant at least when the mutual fund starts investing - most likely investing in target funds takes a while and right from the start there most likely would be only a few target funds. One may also argue that there is sufficient diversification on the target fund level.
Conclusion
It is often said that retail investors in practice have no access to private equity investments. Although there are some examples of public access to private equity, the Finnish market has not seen such structures yet (apart from two listed management companies). As a result of the amendments to the Mutual Funds Act we may in the future see products through which also the general public could invest in private equity. The Finnish mutual fund as an investment vehicle could be ideal for this purpose as it is well known to the public and tax rules are clear and simple.
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