IFRS 10 requires an entity that is a parent to present consolidated financial statements in which it consolidates all of its subsidiaries. However, if an entity is an investment entity under IFRS 10, it is prohibited from consolidating its subsidiaries, with one exception. Instead, it accounts for these subsidiaries at fair value through profit or loss in accordance with IFRS 9 and prepares separate financial statements only. If a parent that is an investment entity chooses to consolidate its investments, these consolidated financial statements cannot be described as being in compliance with IFRS.

An investment entity holds investments for the sole purpose of capital appreciation, investment income (such as dividends, interest or rental income), or both. The most useful information for such an entity is provided by measuring all investments, including investments in subsidiaries, at fair value. Preparing consolidated financial statements for such entities could hinder users’ ability to assess their financial position and results. Consolidated financial statements emphasise the financial position, operations and cash flow position of their investees, rather than those of the investors themselves. Consolidation also hinders comparability within the financial statements; some of the items consolidated might be measured at historical cost, whilst others will be carried at fair value. This makes assessment of the performance of an investment entity difficult, and it does not reflect the way in which the entity’s business is managed.

Accounting by an investment entity

A parent that is an ‘investment entity’ under the standard is prohibited from consolidating underlying subsidiaries, with one exception; instead, it is required to account for these subsidiaries at fair value through profit or loss under IFRS 9.

The exception in IFRS 10 only applies to a parent that is an investment entity.

There are also disclosure requirements in IFRS 12 that apply to an investment entity that is a parent and has unconsolidated subsidiaries.

An investment entity only consolidates subsidiaries that are not themselves investment entities and whose main purpose is to provide services relating to the entity’s investment activities.

This includes investment management services, investment advisory services and administrative support. Such services might form a substantial part of the business and might be provided to third parties as well; this will not disqualify the entity from being an investment entity.

The exception from consolidation extends to the consolidated financial statements prepared by the investment entity’s parent only where the parent qualifies as an investment entity itself. If the parent entity does not qualify as an investment entity, it will be required to consolidate all entities that it controls (including all underlying investees controlled through the investment entity and any other investment entities) under IFRS 10.

Unit of account The term ‘investment’ can consist of both equity (share investments) and debt (receivables) investments. Practice is evolving in the area of ‘unit of account’ for fair value measurement of investments where an investor holds both equity and debt investments in an investee (that is, whether the entity should measure the equity and debt investments as separate investments or as one investment). Entities need to carefully assess the accounting treatment in such situations. The IASB has been discussing this topic, but has yet to make any proposals.

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How does the parent of an investment entity which is not itself an investment entity account for its subsidiary and entities controlled through that subsidiary? Parent is an insurance company, writing insurance business. Parent does not qualify as an investment entity under IFRS 10 because, amongst other things, its purpose is not to invest funds solely for capital appreciation and/or investment income. It sets up a subsidiary, ‘IE’, which manages funds that back some of Parent’s insurance liabilities. Some of IE’s investees are controlled private equity investments. IE qualifies as an investment entity under the criteria set out in the standard.   In IE’s own financial statements, IE measures its controlled investees at fair value through profit or loss. But Parent’s consolidated financial statements will consolidate all of its controlled investees, including IE and IE’s investees.

Definition of an investment entity

An investment entity is “an entity that:

• obtains funds from one or more investors for the purpose of providing those investor(s) with investment management services;
• commits to its investor(s) that its business purpose is to invest funds solely for returns from capital appreciation, investment income or both; and
• measures and evaluates the performance of substantially all of its investments on a fair value basis.”

An entity must meet the definition to qualify as an investment entity. The following typical characteristics of an investment entity must also be considered:

• holding more than one investment;
• having more than one investor;
• having investors that are not the entity’s related parties; and
• having ownership interests in the form of equity or similar interests.

The typical characteristics are indicative and supplement the definition to allow the use of judgement in assessing whether an entity qualifies as an investment entity. If management concludes that the entity is an investment entity in the absence of one or more of the above typical characteristics, it is required to explain in the financial statements why the definition of an investment entity is met. It is highly unlikely that an entity will meet the definition of an investment entity where it has none of the typical characteristics; but it might be possible.

Does IFRS 10 define the specific type of instrument that an entity must hold as its investment? IFRS 10 definition does not specify the type of instrument(s) that an entity must hold as its investment. A key consideration is how the entity manages its investments and not whether the investments are in the form of financial instruments, insurance contracts or other assets. ‘Investment’ might consist of both equity (share investments) and debt (receivables) investments. The analysis of whether the definition of an investment entity is met should consider the business purpose and activities performed by the entity (for example, the amount of strategic advice or active day-to-day management).

Determining whether an entity is an investment entity

The above definition and typical characteristics require consideration of all the facts and circumstances when assessing whether the entity is an investment entity, including its purpose and design. The definition has three key elements:

• investment management services;
• business purpose; and
• fair value measurement.

There is no detailed guidance on the first element of the definition, but the standard notes that the provision of investment management services differentiates investment entities from other entities.

Can an entity which invests in items other than financial instruments meet the definition of an investment entity? An entity’s business is to advance funds to litigants in exchange for a return tied to the lawsuit: ·        In some cases, the return is in the form of an interest-bearing loan secured against the litigant’s rights arising from the lawsuit (‘nonrecourse debt contracts’). ·        In other cases, the litigant agrees to share the future payment on the lawsuit with the fund; however, should the lawsuit fail, the litigant is not required to repay the amount advanced (‘contractual claims’). These contracts contain significant insurance risk and are therefore classified as insurance contracts in accordance with IFRS 4. Can the entity still assert that its sole business activity is to earn returns from capital appreciation, investment income or both? Solution IFRS 10 states that an investment entity obtains funds from investors with the purpose of providing them with investment management services, and commits to its investors that its business purpose is to invest funds solely for returns from capital appreciation, investment income or both. It does not specify the type of investment(s) which an entity must hold. A key consideration is how the entity manages its investments and not whether they are financial instruments, insurance contracts or other assets. The analysis of whether the definition of an investment entity is met should consider the activities performed by the entity: ·        If an entity is involved in the day-to-day management of litigation, it would generally not be an investment entity. ·        If an entity only provides strategic advice and is not actively involved in managing cases and litigation, it could meet the definition of an investment entity.

The standard provides guidance around the second and third elements of the definition: business purpose and fair value measurement.

Business purpose

The purpose of the entity’s business should be to obtain funds from its investors, and to invest them solely to obtain returns from capital appreciation and/or investment income. Its business purpose might be evidenced in:

• documents (such as its offering memorandum, publications and other corporate or partnership documents); and
• the way it presents itself to other parties (for example, to potential investors or potential investees).

How might an entity’s documents indicate that its business objective is that of an investment entity? If an entity states to its investors that it is making medium-term investment for capital appreciation, this will be consistent with the business purpose of an investment entity. But, if the entity presents its investment objective as jointly developing, producing or marketing products with its investees, its business purpose would appear to be inconsistent with that of an investment entity; this is because it suggests that its purpose includes earning returns from development, production or marketing activity.

Part of an entity’s business purpose might be to provide investment-related services (including investment advisory services, investment management, and investment support and administrative services), either directly or through a subsidiary. These services could be provided to investors and/or third parties. Participating in such investment-related services does not disqualify an entity from being an investment entity, even if these services form a substantial part of its business; this is because such services are an extension of its operations. These activities need to be undertaken to maximise investment returns (capital appreciation and/or investment income) from the entity’s investees; and they must not represent a separate substantial business activity or a separate substantial source of income. These permitted activities are:

• providing management services and strategic advice to an investee; and
• providing financial support (such as a loan, capital commitment or guarantee) to an investee.

How does an entity assess its business purpose where it has investing activities and also provides investment-related services? Entities might provide little or no investment management, consultancy or other services, but they will have significant investing activities (for example, mutual funds). In other cases, entities might provide significant investment management, consultancy or other services, with little or no investing activities of their own (for example, asset management companies). It might be clear that the entity is an investment entity (the mutual fund) or is not an investment entity (the asset manager). But, for business models that include both investing activities and providing investment-related services, judgement is likely to be required to determine whether or not the entity is an investment entity. Where the judgement applied is significant, the entity should describe this judgement as one of its critical accounting judgements in the financial statements. A private equity firm that obtains funds from its investors, committing to provide them with investment management services in order to invest for capital appreciation and/or investment income, might be an investment entity. This would be the case even though a significant portion of its activities includes providing sub-advisory and portfolio management services to third parties. IFRS 10 does not specify how the investment entity provides these services, and does not preclude it from outsourcing the performance of these services to a third party. Therefore, if an entity provides investment management services to investors by outsourcing the performance of these services to a third party, it can still meet the definition of an investment entity, provided that the other criteria are met. The entity should consider all relevant factors, and not only the mix of services and investing activity. Factors that are likely to indicate that the entity is not an investment entity are: ·        earning revenue from providing substantial management services or strategic advice to investees; ·        not measuring and evaluating all investments at fair value; or ·        holding investments with no defined exit strategies. Careful consideration of all relevant facts and circumstances will be necessary to determine the appropriate accounting for the entity to apply.

If an investment entity’s subsidiary is not itself an investment entity and its main purpose is to provide investment-related services to the parent, the investment entity parent will be required to consolidate that subsidiary. If the subsidiary is an investment entity, the investment entity parent should measure the subsidiary at fair value through profit or loss.

It might not always be apparent whether a subsidiary of an investment entity is providing investment-related services (and should be consolidated) or is not providing such services (and should be measured at fair value through profit or loss). This assessment could be complicated by some apparent overlap between paragraph 27(a) (definition of an investment entity) and paragraph 32 (definition of entities that should be consolidated by an investment entity) of IFRS 10.

Which investment entity subsidiaries should be consolidated by an investment entity? The first element of the investment entity definition is that an entity obtains funds from investor(s) in order to provide them with ‘investment management services. So, it might be argued that, for a subsidiary of an investment entity to qualify as an investment entity itself, it must be providing investment management services. This could imply that all investment entity subsidiaries of investment entity parents should be consolidated by those parents. We do not believe that the IASB intended that all investment entity subsidiaries of an investment entity parent should be consolidated. Otherwise, the standard would have been clear that subsidiaries falling into IFRS 10 (providing investment-related services) included all investment entity subsidiaries. It seems to confirm that investment entity subsidiaries generally should be measured at fair value by investment entity parents. Our view is that the only investment entity subsidiaries that should be consolidated by an investment entity parent are those which have a separate substantial business activity of providing investment-related services and are not themselves investment entities.

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Assessing whether a subsidiary is providing investment-related services Example – Private equity fund providing guarantee or funding support Facts Two years ago, an asset manager (AM) set up a fund as a limited partnership with 40 limited partners (LPs) and a limited life of 12 years. The LPs are not related; they commit to provide €2,500m. The AM (as a co-investment limited partner) commits an additional €25m, which are its own funds or funds of its employees. The investment objective of the partnership (as set out in the limited partnership agreement) is as follows: to invest directly in entities in order to acquire a controlling or significant share; and to exit these at a later stage through a trade sale or an IPO process (a ‘buy-out fund’) between the eighth and twelfth years of the fund’s operation, with the aim of generating at least a preferred return rate (the hurdle rate) of 10%. The AM (who is the general partner of the fund) directs the relevant activities of the partnership; these include: ·        The appointment of an AM representative to the board of directors of the underlying investee entities. ·        Providing strategic and economic advice to the investees through separate service agreements. ·        Providing and arranging financing and (where necessary) financial guarantees in order to assist investees in executing their strategic plans. ·        Evaluating and influencing the underlying policies, procedures and key management of the investments. The AM considers these activities to be necessary to maximise the overall value of the underlying investees. The AM is also responsible for the selection, management and sale of the fund’s investment portfolio. Based on this, the AM concludes it has control of the fund. The AM is responsible for providing a quarterly individual capital statement for each LP, detailing the fair value of each investment; and the partnership accounts for all its investees on a fair value basis. Each LP interest is entitled to a share of disposal proceeds or net asset values on a winding up of the fund. The general partner (that is, the AM) is entitled to management fees and a profit share of capital gains above the 10% hurdle rate. The partnership has no equity. Is the fund an investment entity, in view of the activities that it performs? Conclusion Judgement is required to conclude whether the fund is an investment entity. The fund meets the first and third parts of the definition of an investment entity: ·        It obtains funds from more than one LP to make investments and to provide them with investment management services. ·        It measures and evaluates the performance of its investments on a fair value basis. The second part of the definition of an investment entity (that is, its business purpose) is less clearly satisfied. The fund makes each investment with the objective of generating capital return and investment income. It does not intend to hold any of its investments indefinitely; this is because it has a limited life and a defined exit strategy for its investees. But it carries out other activities and its business purpose requires further consideration. The fund also displays all four typical characteristics: ·        it holds more than one investment; ·        it has more than one investor; ·        investors in the fund are unrelated to the reporting entity; and ·        ownership interests in the fund are in the form of partnership interests that entitle partners to a share of net assets. Regarding business purpose, the fund is involved in providing other investment-related activities; these include: ·        Providing financial support to the underlying investee, including providing guarantees. ·        Providing strategic and economic direction to the underlying investments. These activities are consistent with the business purpose of an investment entity, and they are permitted so long as they are undertaken to maximise investment returns (capital appreciation and/or investment income) from the investees. But they should not represent a separate substantial business activity or source of income. Judgement is required to make this assessment.

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Should an investment entity fair value or consolidate an intermediate holding company that it uses to hold investments in securities? An investment fund (‘Parent Co’) meets the definition of an investment entity. Parent Co sets up a wholly owned subsidiary (‘Holding Co’) to facilitate the efficient investment in securities. Parent Co provides a loan to Holding Co, which invests the funds in an appropriate portfolio of securities. Holding Co provides investment management services to Parent Co, including the buying and selling of securities and managing the portfolio on a fair value basis. Holding Co also has a separate board of directors and prepares separate financial statements. Should Parent Co fair value or consolidate its investment in Holding Co? Solution IFRS 10 requires an investment entity to measure an investment in a subsidiary at fair value instead of consolidating except where: i. the subsidiary is not itself an investment entity; and ii. its main purpose and activities are providing services that relate to the investment entity’s investment activities. Parent Co should therefore assess whether Holding Co meets the definition of an investment entity, to determine whether it should fair value or consolidate that investment. The assessment of whether Holding Co meets the definition should consider the typical characteristics of an investment entity outlined in IFRS 10: a. It has more than one investment. b. It has more than one investor. c. It has investors that are not related parties of the entity. d. It has ownership interests in the form of equity or similar interests. In the scenario presented, Holding Co does not have two of the typical characteristics (b and c). Further, Holding Co’s objectives and activities are providing services that relate to Parent Co’s core investment activities. Holding Co holds a portfolio of investments on behalf of Parent Co and also incurs associated costs (for example, administration costs and management fees). Holding Co is considered to be providing investment management services and is, in practical terms, an operating subsidiary that acts as an extension of Parent Co. Parent Co concludes, based on the specific facts and circumstances, that Holding Co does not meet the definition of an investment entity and is instead providing services and acting as an extension of Parent Co. In this situation consolidation is appropriate. This is a critical judgement and disclosure in respect of this and the supporting rationale should be provided (in accordance with IAS 1). Parent Co should also consider the requirements of IAS 1 to provide information not presented elsewhere in the financial statements but that might be relevant. Additional disclosure as to what the effect of applying the exception to consolidation would have been on the income statement and statement of financial position (that is, the fair value approach) might be considered appropriate to meet this requirement, because it would provide a user with both sets of financial information. As an investment entity, Parent Co would fair value securities held by Holding Co.

Exit strategy

One of the ways in which an entity’s business purpose will be evident is through having an exit strategy for its investments, specifically documenting how it plans to realise capital appreciation on substantially all of its equity and non-financial investments. The exit strategy should clearly document a substantive time frame for exiting the investments, which might be either an expected date or range of dates, or a time defined by specific facts and circumstances (such as achieving certain milestones, the limited life of the entity, or the investment objectives of the entity). This does not need to be detailed for each investment: strategies could be identified by types or portfolios of investments held.

A business purpose of investing for capital appreciation and/or income is not consistent with an objective of holding investments indefinitely. Most non-investment entities do not plan to sell, list or otherwise dispose of most of their subsidiaries within a particular time frame. A fund, on the other hand, will usually have an exit strategy. An entity should have exit strategies in order to demonstrate a business purpose consistent with being an investment entity. Exit mechanisms that have been put in place only for default events (such as breach of contract or non-performance) are not considered exit strategies for the purpose of the investment entity assessment.

If an entity holds any debt investments that are perpetual, it should have identified an exit strategy for such debt investments.

Holding dated debt investments to maturity is seen as a valid exit strategy; this is because there is no possibility of holding dated debt investments indefinitely.

The following are examples of potential exit strategies for different types of investment:

• Exit strategies for private equity securities can include an initial public offering, a private placement, a trade sale of a business, distributions (to investors) of ownership interests in investees, and sales of assets (including the sale of an investee’s assets followed by a liquidation of the investee, such as when the fund is a limited life fund).

• If an entity has investments in traded equity investments, exit strategies might include selling the investment in a private placement or in a public market.

• An exit strategy for real estate investments might be sale through specialised property dealers or through the open market.

How might entities demonstrate that they have an exit strategy? Exit strategies will often be evident from a fund prospectus or an entity’s investment management agreement. For example, a limited life fund, by definition, has exit strategies for its investments. A fund that instructs its manager to turn over its equity investments at least every five years has an exit strategy. An entity that is set up for long-term capital growth through manufacturing and selling products in a particular market – and which has no explicit plans to dispose of any of its equity investments – might have more difficulty in determining that it has exit strategies for its investments. Such an entity might, in fact, be more like a conglomerate and might not have a business purpose of investing for capital appreciation and/or investment income.

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Does the absence of an exit strategy for debt investments disqualify a fund from being an investment entity? A fund holds investments in both equity securities and fixed-maturity debt securities. The stated objective of the fund is to provide investment management services to its investors, and invest funds received from investors solely for returns from capital appreciation and/or investment income. Assume that the fund meets all of the typical characteristics listed in IFRS 10. The fund’s strategy for holding debt instruments is to manage its liquidity risk and to mitigate the risk of holding more volatile investments. The fund has a documented exit strategy for substantially all of its equity investments, but it has no documented exit strategy for its debt investments. The absence of a documented exit strategy for debt investments does not disqualify the fund from being an investment entity, and it does not contradict its business purpose. The debt instruments have a fixed maturity, so they cannot be held indefinitely.

An entity might meet its business objective through holding some investments in another entity (‘B’) for legal, regulatory, tax or similar business reasons. The entity might not have identified an exit strategy for such investments. However, the entity in which it has invested (‘B’) might have an exit strategy for its investments. Where this is the case, the entity is likely to qualify as an investment entity.

What exit strategies are required in master feeder structures to meet the definition of an investment entity? A feeder fund invests in a master fund and does not have a plan to exit the master fund. But the master fund will make investments and, provided there are exit strategies for those investments, the feeder fund will not be disqualified from being an investment entity. A master-feeder structure (based on example IFRS 10) An entity, master fund ‘MF1’, is formed in 20X1 with a 10-year life. The equity of MF1 is held by two related feeder funds. The feeder funds are established in connection with each other to meet legal, regulatory, tax or similar requirements. The feeder funds are capitalised with a 1% investment from the general partner and 99% from equity investors that are unrelated to the general partner (with no party holding a controlling financial interest). The general partner of both FFD (a domestic feeder) and FFO (an offshore feeder) is the manager of MF1, FFD and FFO. Facts The purpose of MF1 is to hold a portfolio of investments in order to generate capital appreciation and investment income (such as dividends, interest or rental income). The investment objective communicated to investors is that the sole purpose of the master-feeder structure is to provide investment opportunities for investors to invest in a large pool of assets. MF1 has identified and documented exit strategies for the equity and non-financial investments that it holds. MF1 also holds a portfolio of dated debt investments: some of these will be held until maturity, and others will be traded. MF1 has not identified which specific investments will be held and which will be traded. MF1 measures and evaluates substantially all of its investments (including its debt investments) on a fair value basis. Also, investors receive periodic financial information, on a fair value basis, from the respective feeder funds, FFD and FFO. Are MF1, FFD and FFO investment entities? Conclusion MF1 and the feeder funds FFD and FFO each meet the definition of an investment entity. The following conditions exist: ·        MF1 and the feeder funds FFD and FFO have obtained funds for the purpose of providing investors with investment management services. ·        The master-feeder structure’s business purpose (which was communicated directly to investors of the feeder funds) is investing solely for capital appreciation and investment income, and MF1 has identified and documented potential exit strategies for its equity and non-financial investments. ·        Although FFD and FFO do not have an exit strategy for their interests in MF1, they can be considered to have an exit strategy for their investments; this is because MF1 was formed in connection with the feeder funds and holds investments on their behalf. ·        The investments held by MF1 are measured and evaluated on a fair value basis, and information about the investments made by MF1 is given to investors on a fair value basis through the feeder funds. MF1 and the feeder funds were formed in connection with each other for legal, regulatory, tax or similar requirements. When considered together, MF1, FFD and FFO display the following typical characteristics of an investment entity: ·        Although the feeder funds each hold a single investment in MF1, they could be considered indirectly to hold more than one investment; this is because MF1 holds a portfolio of investments. ·        Although MF1 is 100% owned by the two feeder funds, the feeder funds FFD and FFO are funded by many investors who are unrelated to the feeder funds (and also unrelated to the general partner/manager of the funds). ·        Ownership in the feeder funds is represented by units of equity interests.

Earnings from investments

If an entity or another member of the entity’s group can obtain, or is seeking, other benefits from its investees that are unavailable to unrelated parties, that investee is not held with the sole objective of obtaining capital appreciation and/or investment income. Instead, the entity might hold the investment in some operating or strategic capacity. Such an objective means that the entity does not qualify as an investment entity.

Some examples of such benefits, which are inconsistent with an investment entity’s business purpose, include:

• The acquisition, use, exchange or exploitation of the processes, assets or technology of an investee. This includes scenarios where the entity (or another member of the group that the entity is a part of) has disproportionate or exclusive rights to acquire assets, technology, products or services of any investee (for example, by holding an option to purchase an asset from an investee if the asset’s development is deemed successful).
• The entity or any other member of the entity’s group entering into a joint arrangement (as defined in IFRS 11) or other agreement with an investee to develop, produce, market or provide products or services.
• Financial guarantees or assets provided by the entity’s investee that serve as collateral for the entity’s borrowing arrangements or for those of another member of the entity’s group; but an investment entity can use an investment in an investee as collateral for any of its borrowings.
• An option held by the entity’s related party to purchase from the entity, or any other member of the entity’s group, an ownership interest in an investee of the entity.
• Any transactions between the entity (or any other member of the entity’s group) and an investee that:
• are on terms that are unavailable to entities that are neither related parties or related parties of another member of the entity’s group or the investee;
• are not at fair value; or
• represent a substantial portion of the investee’s or the entity’s business activity, including business activities of other entities of the same group.

It is consistent with an investment entity’s business purpose to have a strategy to invest in more than one investment in the same industry, market or geographical area in order to benefit from synergies that increase the capital appreciation of those investments. This is the case, unless the entity is receiving any returns beyond solely capital appreciation and/or investment income by holding such investments.

Assessing whether returns are solely for capital appreciation and/or investment income– high technology fund Facts A fund is formed by Technology Corp Inc (‘TechCorp’) to invest in technology start-up companies for capital appreciation. TechCorp holds 70% of the shares in the fund, called ‘New Opportunities Tech Fund’, and controls the fund. The other 30% of the shares in New Opportunities Tech Fund is owned by a number of unrelated investors. New Opportunities Tech Fund will invest in start-ups; and it will bring together a team of specialists to grow the start-ups. TechCorp holds options to acquire any of the investments held by New Opportunities Tech Fund, exercisable after five years following the purchase of the start-ups by the fund. The exercise price of the options is fair value. TechCorp is likely to exercise the options if the businesses or technology developed by the investees would benefit the operations of TechCorp. No plans for exiting the investments have been identified by the fund. New Opportunities Tech Fund is managed by an investment adviser that acts as agent for the investors in the fund. Is New Opportunities Tech Fund an investment entity? Conclusion New Opportunities Tech Fund’s business purpose is to invest for capital appreciation, and it provides investment management services to its investors. But the fund is not an investment entity, because of the following arrangements and circumstances: ·        TechCorp, the fund’s parent, holds options to acquire the investees owned by New Opportunities Tech Fund if the assets developed by the investees would benefit the operations of TechCorp. This provides a benefit to TechCorp in addition to capital appreciation and/or investment income. ·        The investment plans of the fund do not include exit strategies for its equity investments. The options held by TechCorp are not controlled by the fund (since they are exercisable by TechCorp) and do not constitute an exit strategy.

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Assessing whether returns are solely for capital appreciation and/or investment income– real estate fund Facts A real estate fund is set up to invest in real estate assets for the benefit of institutional and retail investors. It is set up and managed by an investment manager experienced in the real estate business. The fund invests in real estate companies and other real estate investment funds which own, manage and lease out real estate assets. The investment manager has a policy of acquiring and disposing of its real estate investments over a five- to ten-year time frame, based on market conditions. The fund earns dividends and share of profits, and it realises capital gains from its real estate investments. The fund reports (internally and externally) all of its investments at fair value, and its performance is assessed based on those fair values. The fund issues redeemable participating units which are redeemable at a share of the fund’s net asset value (NAV). The founding documents of the fund confirm its objectives and strategy as stated. The fund is not itself involved in the active management of the property portfolio (such as property maintenance, capital expenditure, redevelopment, marketing and tenant selection); this business activity is undertaken by the investees (the real estate companies and other real estate investment funds). Is the fund an investment entity?  Conclusion The fund meets the definition of an investment entity because its objective is to generate returns from capital appreciation and investment income through investment management services. It manages its investments on a fair value basis, which is reported to its investors. It displays the typical characteristics of an investment entity, which are: it has more than one unrelated investor; it holds multiple investments; and it has ownership interests in the form of fund units which represent a proportionate share of its underlying assets. In addition, the fund itself is not involved in the active management of the underlying property portfolio.

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Assessing whether returns are solely for capital appreciation and/or investment income– real estate entity Facts Real Estate Investments (‘REI’) was formed in order to develop, own and operate retail, office and other commercial properties. REI usually holds each of its properties in separate wholly owned subsidiaries. Those subsidiaries have no substantial assets or liabilities other than borrowings used to finance the related investment property. REI and each of its subsidiaries report their investment properties at fair value under IAS 40. REI does not have a set time frame for disposing of its property investments, but it uses fair value to help identify the optimal time for disposal. REI and its investors also use measures other than fair value (including information about expected cash flows, rental revenues and expenses) to assess performance and to make investment decisions. The directors and managers of REI do not consider fair value information to be the primary measurement attribute to evaluate the performance of REI’s investments; instead, they see that information as part of a group of equally relevant key performance indicators. REI undertakes extensive property and asset management activities (including property maintenance, capital expenditure, redevelopment, marketing and tenant selection), some of which it outsources to third parties. This includes the selection of properties for refurbishment, development and the negotiation with suppliers for the design and construction work to be done to develop such properties. This development activity forms a separate substantial part of REI’s business activities. Is REI an investment entity? Conclusion REI is not an investment entity because: ·        It has a separate substantial business activity that involves the active management of its property portfolio, including lease negotiations, refurbishments and development activities, and marketing of properties to provide benefits other than capital appreciation and/or investment income. ·        REI’s investment plans do not include specified exit strategies for its investments. As a result, it plans to hold those property investments indefinitely. ·        Although REI reports its investment properties at fair value under IAS 40, fair value is not the primary measurement attribute used by management to evaluate the performance of its investments. Other performance indicators are used to evaluate performance and make investment decisions.