A recent research paper by Nil Tuchschmid and Erik Wallerstein of the Haute Ecole de Gestion and Louis Zanolin of NARA Capital has taken a long hard look at the relative performance of UCITS hedge funds versus their offshore cousins. The full paper, entitled “Will alternative UCITS ever be loved enough to replace hedge funds?” will soon see the light of day in an academic journal, but in the meantime the findings, while inconclusive, have sparked interest in the issue on the part of managers and investors.

One of the primary differences between UCITS and offshore hedge funds have to be the restrictions imposed risk and leverage, resulting in different risk and return levels. UCITS funds are also restricted in terms of the instruments they can employ, and finally the authors of this paper observe that the enhanced regulatory regime placed over UCITS means funds with more extreme return profiles are less likely to be present in the universe.

Use of leverage is a major consideration, as UCITS funds may not borrow: they can acquire leverage via use of derivative contracts. The key leverage measures are commitment (200% leverage of NAV) and Value at Risk (VaR) and stress test. Use of VaR as a risk metric, as the authors point out, is not without controversy. It does not do well in capturing extreme event risk and it lacks what they call “an unambiguous estimation process” as it relies heavily on the distribution model assumed to represent fund returns.