It has become increasingly obvious this year that many European institutional investors, both those who redeemed money from hedge funds in 2008-09, and those examining the hedge fund option for the first time, have a distinct preference for the UCITS structure, when they can get it. According to figures released by Bank of America Merrill Lynch this year, fund raising by the leading five UCITS hedge funds in Europe was at least as successful as the leading five offshore funds. The real question: will UCITS emerge as the front runner next year?
“The UCITS hedge fund option provides painless access for institutional investors,” says Erik Bissonnier, a Partner with EIM and CIO for Europe. “They don’t have to convince other parties.”
Concerns continue to swirl around UCITS as we approach the New Year: for example, many investors remain concerned about those funds relying on swaps and other structured arrangements. There are worries about conflicts of interest on the part of the large banks providing launch pads for less liquid hedge funds, and the fact that some UCITS hedge funds are being self-administered.
A safe bet?
There is a widespread presumption that the UCITS hedge fund industry offers some kind of regulated avenue that affords investors a higher level of protection than the offshore industry. This has yet to be tested, and it is possible that 2011 will see that test. “Are investors really applying proper due diligence?” asks Bissonnier. “UCITS are not any more or less transparent than hedge funds, they simply enjoy better liquidity. Investors need to know who is pricing the fund, who the trading counterparties are...If you focus on strategies like long/short equity or macro, then the Newcits structure is very appropriate, but elsewhere counterparty risk will be there one day. Managers could be forced to sell positions at the wrong time.”
Bissonnier’s comments help to reinforce the ongoing role of funds of funds in the UCITS space, a sector analysed in more detail elsewhere in this magazine by KdK Asset Management. While the increased transparency and liquidity offered by UCITS means some of the traditional functions of funds of funds are no longer valid, other areas, like monitoring risk controls and providing independent evaluation of back office functions, are still critical.
André Havas, Head of Investor Relations at Stockholm-based fund of funds OPM, says more Nordic institutions are turning towards direct investments into UCITS hedge funds, but he seems optimistic that his firm’s skills are still important. “People are not asking about returns on their money anymore,” he observes. “They are asking when it will be returned. Everyone is concentrating on risk, but what they are only just beginning to realise is that hedge funds can manage portfolios based on risk requirements as well as return requirements.”
Regulations
With the finalisation of the AIFM directive, it sounds as if regulators in Ireland and Luxembourg are shining a brighter light on new fund applications. According to one banking source we spoke to, this is a political development being driven from the very top. Going into November, there were already complaints being voiced about the backlog of fund approvals in Luxembourg, but the slowdown seems to have spread to Dublin as well. Given that more hedge funds are opting for onshore launches – e.g. France and Germany – we may see more going down this route in the New Year.
A German hedge fund boom
Coupled with this, there is increasing interest being demonstrated in hedge fund products by professional investors in Germany. A recent survey sponsored by Man Investments of 400 professional investors in Germany, including IFAs, wealth managers and bank selectors, found that many investors already allocate to hedge funds (the average German family office has over 50% allocated to hedge funds, even post-crisis, according to the report). However, pension funds in the country allocate less than 2% on average.
Despite the anti-hedge fund rhetoric from figures in the German government and business leaders, it seems as if there is wider acceptance of hedge funds in the Central European market than ever before. But, it also seems essential that if funds are to be properly considered, they must be UCITS compliant.
UCITS status will get you into the waiting room, but not in front of the end investor. One hedge fund promoter told us in November that whereas he managed to get only one investor meeting in 2009 in Germany when he was marketing a fund in an offshore Cayman structure, but that with the launch of his UCITS fund in 2010, he had had 42 and counting. This goes to show how the directive is starting to open doors for hedge funds in markets that were previously closed.
Finally, 2011 is also likely to be the year hedge funds start to reinvent themselves as something else, in an effort to get away from the negative baggage that they have picked up - somewhat unfairly - during the credit crisis. This process is likely to begin in the UCITS space as firms begin re-naming their UCITS hedge funds as absolute return funds. Large firms that manage both absolute return long only funds and hedge funds in the same stable are beginning to do this already: it makes them easier to sell, and after all, why bother calling them hedge funds when there remains so much debate as to where the line should be drawn? Some commentators remain unconvinced: OPM’s Havas points out that VaR funds blew up in 2008, regardless of what they were called, but for the end buyer in both the retail and institutional space, dropping the hedge fund moniker could prove to be enough.
Our UCITS predictions for 2011
• An increasing backlog for regulatory approvals, particularly in Dublin and Luxembourg as UCITS funds applications are subjected to increasing scrutiny;
• A series of high profile launches from US-based managers, many of them already famous names in the offshore hedge funds space;
• A rapid growth in interest in hedge funds in Germany, with firms like Aquila leading the charge in the German speaking market;
• Innovative multi-manager fee structures being pioneered by some fund of funds groups as more investors start to question the fixed fee structure in the UCITS hedge funds space;
• More UCITS funds being launched onshore, namely away from the traditional launch pads in Luxembourg and Dublin: expect to see more funds seeking registration in Germany, France and Italy;
• More interest on the part of some larger hedge funds in developing retail distribution networks in Europe, as it becomes increasingly obvious that some of the larger funds in this space are garnering assets through intermediaries and wealth managers who previously did not deal in hedge funds;
• The beginning of the end of the term ‘hedge fund’ in Newcits fund marketing literature as more promoters wake up to the negative connotations of the phrase in the institutional investment world. Such funds will be met half way by long only retail funds adopting more of an absolute return mandate coupled with hedge fund-like fees (only not as excessive – 1.5/10 fee structures are already starting to appear).
