The rush is on this year for alternative investment firms to set up and launch both offshore and onshore versions of Undertakings for Collective Investments in Transferable Securities, or UCITS- and NEWCITS-based funds.
According to a late-December report by London-based KdK Asset Management, some 80% of hedge funds, and in particular funds of funds surveyed by the firm expect to launch a UCITS-based this year (see graph by KdK below) as a way to ensure they are on a regulatory par with more traditional, and accessible, European vehicles.
At the same time, many alternative investment shops have been rushing to create what are called “NEWCITS:” onshore, regulated UCITS funds.
Why the rush to UCITS and NEWCITS? For starters, UCITS funds are already regulated, they 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.
For NEWCITS in particular, the survey noted than 90% of fund of funds believe they will have lower returns than their equivalent offshore versions, with a quarter expecting the shortfall to be greater than 3 percentage points a year.
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.
According to various media reports, including this one, the reasons are somewhat different than the survey suggests – that managers are setting up UCITS and NEWCITS funds because of uncertainty surrounding the Alternative Investment Fund Managers (AIFM) Directive from the EU. (You can read all about the directive and the industry’s response to it here.)
Why else would a firm establish a fund with higher costs and more limited investment parameters?
Either way, the funds have their work cut out for them in terms of delivering performance. Among other things, they are:
- Prohibited from directly investing in commodities and physical shorting, which can limit a hedge fund manager’s ability to deliver its investment strategy in full.
- A UCITS is not allowed to borrow for investment purposes. It can only obtain (limited) leverage through derivatives.
- The maximum redemption period for a UCITS is 14 days and redemptions must be made in principle at the fund’s net asset value, limiting the ability of managers to take positions in illiquid assets or illiquid strategies.
UCITS funds have a formal market risk management process which must be in place due to restrictions on the way value at risk is calculated and there must be regular stress testing. Additionally, they must offer, as they Brits say, fortnightly liquidity, at the very least.
Among the firms to have taken this approach include: Brevan Howard, GLG Partners, Man Group and Odey Asset Management – four large London-based managers. And more are expected to follow.
Three quarter of the survey respondents confirmed there is demand for such funds from retail networks and fund platforms or fund distributors. Interestingly, more than two thirds also had demand coming directly or indirectly from high-net-worth individuals, which is significantly more than the demand coming from institutional investors. And many aren’t convinced that they do any better a job of allaying investors’ concerns than managed accounts do, as the chart below shows.
Whether part of a bid among larger hedge fund firms to get ahead of the EU directive or just another way to offer a regulatory compliant fund with that fits with the new era of risk management, it remains to be seen how many of these funds survive and thrive. We’ll be interested to read the results of KdK’s survey in December 2010.