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Ucits: hedging your bets

Written by Matt Ritchie
September 2011

Matt Ritchie explores how Ucits funds are developing and what their influence is on alternative investment strategies

Since the Ucits III principles were adopted at the end of 2001, investment managers have been able to develop products under the Ucits tag that embody
a number of the characteristics of ‘traditional’ hedge funds.

Ucits III opened the door to taking advantage of a range of derivative techniques, enabling investors to invest in Ucits funds with access to methods previously unavailable.

The European Fund and Asset Management Association (EFAMA), among others, has noted the rush toward these so-called ‘Newcits’ strategies following the economic collapse three years ago.

The funds can offer exposure to long/short equity positions, tactical trading and global macro, whilst providing comfort for investors through the transparency and liquidity requirements imposed by the Ucits framework.

Recent EFAMA statistics for the investment fund industry (excluding Belgium, the Netherlands and Liechtenstein) show the trend of investors flocking to Ucits in general continues apace. Funds in Ucits amounted to €5,928 billion at end May 2011, an increase of 1.1 per cent since end April. Meanwhile, total assets of non-Ucits grew 0.9 per cent to stand at €2,097 billion.

Long a vocal advocate of the development and take up of Ucits, earlier this year EFAMA undertook a study covering the ‘evolving’ investment strategies of the funds.

A report was published on the issue in May, in which the association cites a 2010 project from Strategic Insight indicating that while the Ucits universe is expanding in general, the newer products are growing faster.

Head of alternatives and hedge funds at Dexia Asset Management Fabrice Cuchet stresses that the rise of Ucits – encompassing all the various strategies that come under that banner – has been taking place since well before 2008.

"There is a rise of Ucits funds, but it did not start with the 2008 crisis. We were already managing alternative Ucits funds since before 2000, as many European pension funds and institutional investors were investing in such Ucits funds prior to the crisis," Cuchet says. "But, growth has exploded since the crisis due to increased demand for regulated products: investors are looking for liquidity, transparency, and regulated funds."

Meanwhile, the current economic environment acts to draw investors toward the absolute return style that alternative strategies can offer. Volatility and sluggish performance from risky assets over the past decade have served to illustrate the benefits of diversification, Cuchet says.

In addition, developments in the regulatory space are serving to increase the number of Ucits alternative products in the market. The looming Alternative Investment Fund Manager's Directive (AIFMD) is providing the impetus for managers to introduce hedge fund-like strategies under the Ucits badge.

Alternative investment funds are not covered by Ucits, and include
a range of products including hedge funds, private equity and real estate. According to the European Commission, the AIFMD seeks to "create, for the first time, a comprehensive and secure framework for the supervision and prudential oversight of AIFM in the EU".

The directive aims to increase the transparency of alternatives, enable regulatory authorities to monitor and respond to risks arising through activity in the alternative space, and foster increased investor choice and competition in the EU.

Clearly, there are parallels between what the Ucits framework seeks to achieve, and the aims of the AIFMD.

Introducing the new directive has been a protracted process, giving rise to a fair degree of uncertainty across the alternatives space as to what changes will be necessary once it has finally been introduced. This has been cited as a reason for bringing alternative strategies onshore and under the Ucits banner.

The new hedge funds?
Alternative Ucits strategies, then, offer value to investors via a channel that managers want to use.

However, this does not necessarily mean that Ucits alternative strategies are the same as traditional hedge funds. The requirements a fund must meet in order to qualify for the Ucits badge prevent the products from offering the same value as a more conventional hedge strategy.

Cuchet says the liquidity requirements of Ucits are such that investors will not have access to the same level of returns they can achieve through investing in classic hedge fund strategies.

It would be a mistake to try to pit hedge funds against Ucits alternative strategies, as they are different products which will suit different investors, he says.

"They're not the same because they have different constraints. And, you have some investors – like pension funds – with very long-term investment horizons, looking for hedge funds, and liquidity is not their key selection criteria. For them there is not a lot of interest in Ucits alternative funds.

"It's clearly a new dimension and I think this new dimension is a crucial point for the development of Ucits. But I completely disagree with those who are trying to sell Ucits funds as a replicator of the hedge fund universe."

AXA Investment Managers' Aarnout Snouck says the Ucits alternative funds will always be more of a 'beta' product, and investors need to ask themselves what they are getting in return for foregoing the illiquidity premium that accompanies traditional strategies.

Risks
Whilst Ucits offer a degree of regulatory protection to investors, Snouck stresses that this should not be confused with the funds being risk free. "We have to be careful saying that the Ucits product has far less risk. You need to do the same due diligence on Ucits funds as you do on offshore funds. There are other risks in Ucits products. For instance, although people have a
lot of confidence that a product has the Ucits stamp on it, if you're using swap structures to shoehorn strategies into a Ucits format you create new risks."

Director of Trinity Fund Administration, Peter O'Dwyer, says Ucits as a concept and product is "probably the most successful thing the EU has ever done", but is concerned that forcing hedge fund type strategies into a Ucits framework risks damaging the brand.

"For a whole variety of reasons – one of which is the AIFMD, another is other international regulatory pressures on alternative managers – there's been the perception that you could mimic hedge funds in Ucits. That has also been facilitated by consultants and people who would advise hedge fund managers.
"However, it's absolutely the case that Ucits were never designed
for that from the start. It would be a shame if the Ucits brand became tainted by this. Ucits should be used for the purposes for which they were originally intended."

EFAMA does not share these fears. While urging against categorising the newer Ucits strategies as being somehow distinct from more traditional products, in its report on the evolution of Ucits the association said it has "full confidence" that regulators can continue to supervise practices to ensure investors have access to products which offer value while maintaining a high degree of consumer protection.

In particular, the association welcomes the creation of the European Securities and Markets Authority, which entered into being in January this year through the ESMA regulation.

"The universe of Ucits is evolving but this is encompassed by the Ucits regulatory framework. Moreover, the regulatory requirements and supervisory tools are being further developed and articulated, especially under the Ucits IV framework."

EFAMA stressed that alternative strategies do not constitute a "novel" category of funds, as they are governed by the exact same rules and processes which apply to all funds carrying the tag. Indeed, the association urged against using the Newcits tag at all.

"The so called 'Newcits' are neither new products nor a new category of funds. 'Newcits' are Ucits that can be described as aiming actively to manage the risk/return trade off. They are subject to and are managed in compliance with the Ucits framework. As such they offer the same level of investor protection as other Ucits.

"The 'Newcits' label was coined by the media and should not be adopted by the industry or regulators. We do not believe that it is necessary
or beneficial to have a specific label of these funds."

Written by Matt Ritchie



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