The birthday guest guide to investment firms

It is in lawyers’ DNA to answer questions with a million “in principles”, “shoulds” and “it depends”. The answer might sound impressive but is totally incomprehensible for the average birthday guest. The way out for the birthday guest is to nod politely, pretend that all is understood, and redirecting to the party. A smart escape for the lawyer but the birthday guest still does not have a clear answer. We lawyers owe some clarity to the birthday guests. So, let’s clear things up for once and for all, in a digestible manner.

An investment firm, tell me all about it

An investment firm is a company that knows where to find money and invest it wisely. They put money into businesses, help them grow and sell them after several years. So, where does this money come from? A lot of it comes from large investors, like pension funds (or insurance companies, multinationals etc.). These pension funds need to invest the premiums they collect to generate profits, so they can provide good retirement benefits to their participants.

Investment firms don’t bet on one horse and provide TLC

To generate profit, pension funds can invest the premiums they collect in the stock markets. But betting on just one horse is known to be the biggest sin in investing. Like you, investors don’t put all their eggs in one basket. They spread their bets and invest in a diverse range of asset classes like private business, real estate, crypto, infrastructure, bonds, and public stocks. Investments in private business are made with the help of investment firms. Private businesses need day-to-day attention – also called “tender love and care” or “TLC” – to increase their value, and that is exactly what investment firms provide. For this reason, pension funds don’t invest directly in private businesses; instead, they invest through investment firms that manage and grow the businesses for them.

Investment firms pool all the money in a pot and take out a cookie for themselves

How are the investments in these businesses organized? The investment firm pools all the money it collects from investors together in a “pot”. This pot of money is what we call a “fund”. This fund is used to buy the private businesses and is managed by the investment firm. Management means finding the right businesses to invest in and growing the businesses. The investment firm charges the fund an annual fee and takes around 20% of the overall profit. Any remaining profit goes to the investors. The investors pay these fees and share the profit for having the investment firm manage their investments and grow the businesses on their behalf.  

The pot must be a safe Luxembourg iron vault

Where does Luxembourg come in? The teams that focus on management of funds flock together in major financial centers (like London and New York) as that is where the business deals are made. The fund that pools the money, must be organized in a country that investors feel safe with. Metaphorically speaking, it’s safer to put your money in an iron vault than in a piggy bank. Especially EU-based investors, feel most safe if they can put their money in a what you might call a “Luxembourg iron vault”. US investment firms looking to attract EU capital find greater success when they offer the (Luxembourg) iron vault rather than the piggy bank. Offering a fund situated in another country is like a mobile phone operator selling subscriptions with a complementary Nokia 3210, rather than the latest iPhone model. Investment firms don’t feel pushed towards a Luxembourg fund; they appreciate a Luxembourg fund as it can also easily get the required permission to approach investors throughout the whole EU. 

The backbone of Luxembourg’s funds industry

The fund requires day-to-day maintenance which requires hands. The hands of lawyers, bankers, accountants, tax specialists and administrators. These professionals fill Luxembourg’s restaurants, lunchrooms and… highways. Funds that invest in European companies set up legal entities that acquire businesses. These are called holding companies. Guess what? These entities are also in Luxembourg, simply because the fund is already there and because Luxembourg entities are business friendly. A holding company also needs maintenance, so even more manpower is needed.

The business love affair

To make a long story short, US investment firms are head over heels for Luxembourg. This love affair is based on business reasons: they can easily attract EU investor’s money through Luxembourg and the more money they attract, the more they can make. The creation of such an environment is the result of decades of unprecedented and robust politics, and stability! A round of applause for our politicians.

Our romantic nature tells us that a genuine love affair between the US and Luxembourg cannot be driven by business alone, we bet there is also some romance between the two countries... Let’s delve into that aspect another time.

This article was first published by the Luxembourg Times, and is also available in German on Wort.lu.