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Investment Clubs

Investment Clubs

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1. What is it?

An investment club, as it sounds to be, is when a group of people unite in order to pool money and invest, for instance, in stock options. The investment club is formed by individuals, just like a condo, who have common interests. They can be formed from working colleagues or friends, for example, who meet with the purpose of investing tehir savings in the financial market. With the volume of money they can raise together, it becomes possible for them to invest in some options which would not be acessible for smaller investors, either for a lack of resources or for some market requirements or rules.

To create an investment club, at least 3 people must be involved as members or quoters, and 50 people at most. Those people will be making deposits which will be forming the club’s equity. The club must have a name, which can’t be inappropriate or misleading, and must appear respectable and serious to the market. Investment clubs don’t have necessarily a limited lifecycle, but can have an expiration date if members decide to and write it down properly. The club’s bylaw will determine rules for new people to join it, for buying or selling shares, as well as fees and performance charges rates.

Investment clubs are subject to CVM rules (the equivalent to USA’s SEC), and must be managed by a financial institution, with the fund being administrated by an accredited professional.


2. How does it work

Investment clubs must follow some rules imposed by CVM and the stock exchange. Moreover, they have particular characteristics, such as quotas or administration fees, as well as some agents that are part of the club,  like a manager or administrator. Below we list the most important parts that comprise an investment club.

Portfolio

The portfolio of an investment club is nothing more than the group of assets that compose its fund. The assets may comprise shares or stock, public or companies’ notes and bonds, options and any other financial asset. However, the clubs must have at least 67% of their funds invested in:

  • Share
  • Convertible notes or debentures from opened companies
  • Quotas at indexed funds of shares
  • Depository receipts
  • Issuing bonuses (negotiable notes that grant the holders with rights of buying a company’s shares for a particular period, at predetermined prices)

Above 67% of the existent funds, the money can be invested in:

  • Any other notes and bonds issued by opened companies
  • Quotas at investment funds described as “short term”, “fixed income” or “denominated”
  • Government bonds
  • Notes backed by financial institutions
  • Stock options

Administrator

It is legally responsible for the fund or club, and must protect the members’ interests. The administrator must be mandatorily a broker, a notes issuer or an investment or multiple bank. The selected administrator will be dealing with all documents and registrations for making the club operational, as well as managing that.

Among its duties are the registration and identification of each member, assemblies calls, balance sheets and financial reports and also behave as better as possible to avoid operations that can cause any damages to the club’s funds.

Custodian

The custodian is the keeper of all club’s assets. It also reports to administrators with data and information related to all assets involved, and is responsible for Market-to-market. Custody is usually taken by CBLC (Companhia Brasileira de Liquidação e Custódia). Thus, if the administrator goes bankruptcy, the assets will be still under CBLC’s posession.

Manager

The manager is the financial institution that operates  on buying and selling the club’s assets and investments, looking for better profit margins and following the rules determined by the club. The manager can be either a bank or an independente company, as long as it is accredited by CVM. It chooses which financial assets should be purchased and which positions should be taken, as well as the volume of notes, shares or assets to be purchased, and of course, the best moment to sell them out, always respecting the bylaw club.

If portfolio assets are not in accordance with the club’s rules and requirements, the manager must rearrange the investments to meet the club’s requirements as soon as possible.

Quota holder

The quota holder is the individual investor who puts his money in an investment club. For such, they buy a certain number of quotas of the club they want to invest in, agreeing to pay a determined price for each quota, including fees and charges from administrators, who is to coordinate the fund and the investments.

When buying quotas at a club, the investor automatically accepts all of its rules, like minimal values to invest, times and deadlines for investing or withdrawing cash, pro-rata expenses, anything equal to any other quota holder, no matter how many quotas he can have.

Any holder must be acquainted with the club’s objectives, administration fees and perfomance fees (if any), as well as receive monthly reports on investments, conditions to withdraw quotas (if there are), and the value of quotas,  the fund’s balance and the portfolio and tax reports.

The quota holder must sign a statement of acceptance, a trust document that attests he got prospects and rules for the club and is aware about its code of conduct, and all risks attached. No quota holder is allowed to hold more than 40% of a club’s quotas.

Quotas

Quotas are a fraction on a club’s total assets. They are indivisible, book kept and nominative, and cannot be given or transferred, except by law.

When an investor invests in a club, he is acutallu buying quotas on that, whose value is daily updated. The value of a quota is movable as its portfolio changes, and depends on how the club’s assets are invested. This way, it an ever-changing value, except if:

Quando um investidor aplica recursos em um determinado clube, ele está comprando cotas desse clube, cujo valor é calculado diariamente. O valor da cota muda diariamente, pois o patrimônio do fundo se valoriza a cada dia, conforme as aplicações feitas no mercado. Dessa forma, o valor da cota muda diariamente, porém a quantidade de um investidor será sempre a mesma, but the amount of quotas holded by an investor is always the same, except when:

  • The investor withdraws cash, reducing his position on quotas;
  • The investor makes and new financial move, increasing his number of quotas;
  • Two tax payment dates set by the government: the last day of both November and May, each year. This process of “eating” part of the quotas held by an investor to satisfy income tax payments is what’s known as Quota-eating.

To find the quota’s par value, one must divide net assets by the number of quotas. If an investor multiplies his number of quotas by the par value, he can find how much money he has on the club, before taxes.

Administrative fees

The charged administrative fee aims to serve as payment for the services rendered by the administrator. The value usually accounts for expenses with management, investment consulting, treasury, control and processing of assets, registering all quota movements in the books, among other things. This fee is detailed in the fund’s bylaws, and is usually charged based on a percentage of the total annual net assets of the fund (252 workdays). This fee is also calculated daily, so all statements already account for this amount being withheld from the total informed.

Because of its nature, the administrative fee will directly impact the profitability of a fund – and that should always be taken into account when choosing a place to invest. Fees that surpass an average of 1% a.a. will already have a very serious impact on the bottom line.

Performance fees

Performance fees aim to serve as payment for the ability displayed by the administrator or the manager in surpassing the profitability anticipated by the fund’s reference indicator. As a practical example, in a fund is referenced at 104% of the DI rate and the manager or administrator manages to presente higher profits, they may charge a fee for surpassing the initial mark. Performance fees are not, however, charged by all clubs – nor are they mandatory.

Performance fees may only be charged once all other expenses have been provisioned for. They’re usually charged every six months and are also calculated and withheld daily.

Expenses and duties

Asides from administrative and performance fees, other expense and duties are due by investment clubs. Among them:

  • Expenses pertaining from notary public charges, printing, expediting and publishing reports
  • Taxes and duties over assets and other such properties of the fund – like payroll taxes, for instance.
  • Mailing expenses
  • Independent auditing expenses
  • Possible legal fees and charges
  • Custody and liquidation expenses
  • Bank fees
  • Stock exchange and CVM (the Brazilian SEC) charges

Entry and exit fees

Although not yet common in Brazil, local legislation does allow for the charging of entry and exit fees. This type of recourse is very common in the US market and aims to making investors keep their money in the fund for the longest possible time. Longer investment commitments allow for trading in longer term bonds and, therefore, for a higher possible profit.

Bylaws

The bylaws of an investment fund are a document where all rules and operational principles of this investment club are stated. Here the rules and regulations to which the administrator and manager are subject will be detailed, as well as investment policies, minimum investment requirements, general meetings and such. Basic details available in one such document are:

  • Appointment of an administrator, manager and custodian
  • Duration period: determined or undetermined
  • Investment policies (main portfolio directives, possible derivative trading restraints and such)
  • Administrative and performance fess (if existing)
  • All duties and operational costs
  • Management regulations and mandates
  • Rules for calling and conducting general meetings
  • Etc.

The bylaws may be altered by general meetings. All changes will be effective after 30 days, except if otherwise provisioned by the totality of quota holders.

Registration

The registration of the investment club shall be held solely by the administrator. To access the registration system, the club must submit the documents to the Bovespa as the statute approved by the Central Bank and registered in the Commercial Registry. With no irregularities or inconsistencies, the registration will be done in a period of 30 days.

General meetings

The general meeting of shareholders is a meeting to discuss on certain matters relating to the Investment Club, such as:

  • Financial reports
  • Replacement of the administrator or the manager (if the latter was initially elected by a general meeting)
  • Merger, incorporation, break, transformation, dissolution or liquidation of the fund
  • Rise in administrative fees
  • Change in the fund’s investment policies
  • Change in the bylaws

General meetings are called annually, within 120 of the end of the current mandate. It may be held via videoconference, conference call or via internet. The meeting may be called by the administrator, by a request made by the manager or by quota holders’ requests – provided the group requiring the meeting represents no less than 30% of the holders or of the total amount of quotas issued.

Further regulations are provided by the CVM’s 409/2004 instruction.


3. How to set up an investment club

First step for setting up a club is to unite a group of people with common interests – investing in financial markets with similar views, deadline needs, profitability expectancies. Such group must have at least 3 people and no more than 50, and none of them can hold more than 40% of the club’s quotas.

Secondly, an administrator needs to be appointed. It can be a broker or a bank. It will be managing all red tape involved, setting up rules and bylaws, organizing the quota holders and their registration, providing balances, etc.

Thereafter, an investment policy needs to be set and written down on the club’s bylaws. Members must choose a focus, if the club is going to invest on Ibovespa’s shares only, or seeking some stock which historically pay good dividends, etc. Bylaws contain all rules, policies, fees involved and the code of conduct for the club.

Once the bylaw is done, the club must be registered and then it is ready to start operating, being able to attract new members to the limit of 50. Clubs are subject to CVM and Bovespa dilligences.


4. Differences between and investment club and an investment fund

The main point of difference between an investment fund and a club is on the way the assets are managed. On clubs, management can be left to the participants, if they so choose. On funds, quota holder cannot, under any circumstances, manage or choose the assets that will compose the portfolio.

Another basic difference is that, in a club, the maximum number of participants cannot exceed 50. For funds, the number is unlimited. Costs and legal documents needed to start a fund are also higher and more complex.

Both, however, are subject to CVM and Stock exchange rules and regulations, and have similar operational premises.


5. Profitability

Profitability of investment clubs varies greatly, and is usually profoundly linked to the club’s specific strategy, assets of choice and general economic factors. Since the manager is responsible for choosing assets, a highly trained professional may maximize profitability – although there are no guarantees they will. It is very difficult to predict future profitability of a club, not only because of the assets of variable income, but also because good past numbers cannot foresee similar results into the future.

To find all investment clubs and their info and details, please access Bovespa’s website:

http://www.bmfbovespa.com.br/clube-de-investimento/clube-de-investimento.aspx?


6. Risks

Market risk is a factor when dealing with investment club. This means all investments made in this fashion are subject to market fluctuation: on currency, interest rates, stock prices, commodities and such.

When choosing an investment club, one should always account for the possibility of losing money, or even having to cover further losses of the fund – however rarely.

The strategy is key for this type of trade. Risk levels for fixed income clubs, for instance, will necessarily be smaller than for stock exchange clubs. Knowing this is paramount. If one cannot accept they might see their money lose value, investment clubs may not be the best choice.


7. Taxation

Based on the typesetting of the fund’s portfolio, taxation occurs in two basic forms:

1. If more than 67% of the portfolio is made up of stocks, issuing certificates, depository receipts, Brazilian Depository Receipts (BDR), stakes in stock funds and stakes in stock index funds, the income tax rate will be 15%.

2. If the assets detailed above make up less than 67% of the club’s portfolio, income tax rates follow the table below:

  • Investments for up to 180 days: 22.5% (only over profits)
  • Investments between 181 and 360 days: 20% (only over profits)
  • Investments between 361 and 720 days: 17.5% (only over profits)
  • Investments over 720 days: 15% (only over profits)

Income tax will be calculated based on the positive difference between the value of the quota when acquired and the value of the quota at the time of redemption. This means charges will only be made if there is a real profit. Any losses made on redemption made be compensated on future redemptions (if they show a profit) of the same club. Loss compensations can also be made via redemptions on other clubs of the same nature, provided all funds are administrated by the same company.

Income tax payment is the responsibility of the club’s administrator, and it must be withheld at the time of redemption and paid on the 3rd work day of the week following the redemption date. Quota-eating will not occur. Clubs are exempt of IOF tax, though.


8. Advantages

  • Not much needed to invest;
  • No need of being a specialist for investing;
  • Access to many types of investments, some not usually available to smaller investors (diversification);
  • You choose what kind of club you’ll be investing (and the strategy it gets);
  • Smaller costs if compared to investment funds;
  • Lower administration fees;
  • You can help managing the club;
  • Withholding taxes.

9. Disadvantages

  • Not backed by the guaranty fund;
  • As the clubs mostly invest in shares, people who are averse to risks or not used to stock exchange ups and downs should not be opting for that;
  • For clubs formed by relatives or friends, when profits are low, conflicts can affect relationships;
  • Even with the direct participation of shareholders in the management of the club, the manager of the club shall be a qualified professional with knowledge of the market, because he can minimize risks;
  • Administration fees can affect the club’s profitability;
  • When you invest in a club and leave the management of resources in the hands of third parties, you submit the will of the majority of shareholders, which may cause conflict of interest with their investment objectives and the investment objectives of the Club.

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