UCITS enjoy a very high level of recognition in Europe and beyond; it has become the ‘gold standard’ of investment funds, leading to a proliferation of products with total assets under management in excess of €5.6 trillion at the end of the second quarter of 2010. The market for UCITS hedge funds is growing rapidly in terms of number of funds and in terms of assets under management. Investor demand is strong, fuelled by concerns about transparency, risk management and liquidity. As a result, funds of hedge funds are also entering massively in this space with more than 66 multi-manager UCITS launched to date. Over the past 12 months, at least 31 UCITS funds of hedge funds were launched and assets under management grew in excess of 150%.
The objective of this report is to provide for a series of charts summarizing the developments in this space and an attempt to derive the main trends in the industry.
Trends
Funds of hedge funds’ assets under management have fallen by roughly 40% since their peak, while direct investment in hedge funds has grown by a few percent. Investors continue to pull money out of funds of hedge funds. Single manager funds in contrast have resumed attracting money (See Fig.1).
This is consistent with what we have been observing in the UCITS hedge funds space. Multi-manager products struggle to gather significant assets whereas single manager UCITS are reasonably successful.
Over the past year, we have witnessed the launch of a significant number of UCITS funds of hedge funds (31). Asset gathering, however, has been relatively modest (€2.82 billion), which represents, nevertheless, a growth of 154% YOY (from €1.83 billion).
Luxembourg- and Irish-domiciled funds contributed for 90% of the growth in AUM (61% and 29% respectively) with Irish funds being the fastest growing in relative terms.
It is interesting to point out that new funds are increasingly domiciled in these two jurisdictions. Since service providers there have developed an expertise specifically for international fund distribution, this may be an indication that the ability to distribute in a larger number of jurisdictions is becoming more important.
In terms of investment structure, we are also in the presence of a clear trend. Index approaches used to be the most common way to deliver multi-manager hedge fund exposure but, probably as a consequence of the stellar growth of UCITS hedge funds, the direct investment approach, “UCITS Square” (or UCITS of UCITS), is now becoming increasingly popular (See Fig.4). When dealing frequency is concerned, we note a shift to less frequent liquidity (See Fig.5).
In terms of fees, we also see a shift towards slightly higher management fees and more funds taking performance fees.
Conclusion
Although one could argue that UCITS funds of hedge funds failed (so far) to gather significant AUM, we believe that this sustained new fund launch rhythm will continue for some time. Interestingly, a large proportion of the latest launches are managed by “non-traditional” funds of hedge funds managers.
It is unclear whether this is a consequence of the fact that investors are not convinced that only experienced fund of funds managers can deliver attractive returns or whether the price tag of such experience is deemed too high by these investors (read fund distributors).
It is probably not the time and the place to discuss at length if a private bank should hire an experienced fund of hedge funds manager to manage such an offering or if the investment management should be internalised. It is like asking whether buying a (long only) equity fund is better than buying an ETF, we’ll never know for sure.
The bottom line is trust: fund promoters have to (re-)gain the trust of the investor to sell. Recent history is not on the side of the traditional funds of hedge funds providers, who are widely criticised for not having been able to prevent losses in 2008. They are also often blamed for having invested with Bernard Madoff or for having gated their investors…
Operating under the UCITS label does not magically restore trust, there is still a lot of work to be done. Funds of hedge funds’ managers will have to demonstrate and convince that they can add significant value, which should mainly take the form of:
1. Better manager (or fund) selection,
2. Superior asset allocation (or portfolio construction), and
3. Effective risk management.
The investment strategies underlying UCITS hedge funds are often complex and their implementation not always straightforward. It is not only key to be able to assess whether a specific manager is talented and disciplined, it is also vital to understand if he transfers over the knowledge and the resources to effectively transpose this talent and discipline in a UCITS.
Absolute return products have not reached the masses yet. We are only at the beginning of a fundamental change in the industry if we judge by the type of requests we are getting from investors.
When UCITS funds of hedge funds managers will find better ways to present their offering, it is very likely that we will see an explosive growth in AUM for this type of products, and that regardless of the prevailing macroeconomic environment.
