Despite performance concerns, UCITS-compliant hedge funds still have plenty of fans

European investors UCITSLike fans of an aging rock star, European investors continue to flock to UCITS-compliant hedge funds despite some recent concerns about waning performance.

Deemed the structure du jour back in January, the concept has been covered ad nauseam in the press and on the conference circuit as a way for investors to earn returns in a hedge fund structure that follows very specific EU guidelines.

Indeed, according to a London-based KDK Asset Management, the number of UCITS funds continues to mushroom, with an additional 125 funds launched in the first five months of 2010, with total net inflows standing at US$12 billion, according to its latest report. That compares to 200 such funds counted by KDK in its last report on the space a few months ago.

UCITS are also exploding in the FoHF space, with more than 50 multimanager UCITS launched to date, according to KDK. All told, since KDK’s last report in April (read our “UCITS and NEWCITS: A better mousetrap?” for AllAboutAlpha.com’s analysis of that report; check out all our recent UCITS-focused coverage) UCITS funds have attracted 20% of total net inflows into the industry year-to-date 2010.

And the number of those following these rock stars continues to grow: In KDK’s latest survey, 40% of responded said they had already launched a UCITS fund since being surveyed at the end of 2009, and a full 96% said they had considered launching one in the past six months (see two charts below).

So what’s the attraction? According to KDK’s survey, the benefits are that they are already regulated and offer the comfort of a trustee or depo bank as holder of the assets, while some of the counterparty risk concerns raised by the role of the prime broker in a typical hedge fund can be mitigated with a custody agreement.

But, as many have pointed out, there are also drawbacks, in particular on the performance side of things. In fact, according to the survey results, respondents believe that the implementation of the same investment strategy in a UCITS structure impacts performance negatively, reducing the potential for return as compared to the same strategy delivered in an offshore fund.

Beyond that, many see the move as mainly being motivated by the ambition to gather more assets from sources that are no longer accessible through offshore funds or managed accounts, thanks to either new or pending regulations.

What’s more, the majority sees most hedge fund strategies as not yet offering enough choice in terms of UCITS-compliant funds or managers. The chart below illustrates respondents’ perspectives on various strategies and asset classes, which shows that save for long/short equity and to a lesser extent CTA, most do not see UCITS funds as yet ready for prime time.

What it boils down to is whether investors and managers feel there is additional value-added in a UCITS structure versus a separate managed account or offshore vehicle. According to KDK, the reason why most appear to prefer UCITS over a managed account structure is that real managed accounts are not accessible to smaller investors, and many can’t cope with the operational burdens.

What’s more, UCITS’ perceived main benefits – namely liquidity, transparency and embedded regulatory oversight – are viewed by the majority as well worth the effort and price. In other words, many managers feel they can get the same or better results for their investors by setting up a non-UCITS fund structure outside the EU.

Aging rock stars such as Paul McCartney and the Rolling Stones continue to play to sell-out audiences.  But this usually isn’t because they are still at the peak of their game.  Instead, it’s because they are providing access to new generations of fans – fans who grew up hearing about these legends but who were too young to attend a concert (or in many cases, were not yet born).  Likewise, UCITS allows a new category of investor to experience hedge funds.  And like the newest generation of Stones fans, they seem to appreciate it – even if a few of the riffs are a little off.

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