This has been discussed at countless workshops, conferences and meetings so without regurgitating the same views such as investors’ need for liquidity and regulatory oversight, we can draw reference to a recent Deutsche Bank survey where investors predicted that $185 billion will be placed in absolute return UCITS funds in the next 12 months. This will double the current absolute return UCITS market, dwarfing the expected inflows to offshore traditional structures over the same period.
We are beginning to witness the emergence of the most important but most protected investor of them all – the retail investor. This is an overused and often incorrect description of a huge community of potential allocators, but for the purposes of this article we will include private banks, wealth managers and independent financial advisors (IFAs).
The days are quickly disappearing where it has been acceptable to a client for his or her advisor to call him and inform him that he owes them lunch, as they beat the market by 2% (with the market being down by 31% over the course of the year, as happened in 2008). Coupled with the realisation that hedge funds were not to blame for the fall-outs of 2007/8, the figures discovered by the Deutsche Bank survey recognise that investors want exposure to risk managers who can protect their capital and maybe even generate some positive returns in a downturn. The decision is also made easier in that advantageous tax treatment is now possible for European-regulated vehicles in most EU countries.
However, the transfer from the laid-back beaches of the Cayman Islands, the Bahamas or Bermuda to the hostile and heavily regulated European arena is not an easy one. With the high fees and enormous incomes available to hedge fund managers there will always be an understandable suspicion by the retail community, despite the obvious lure of absolute returns.
Managers have to instil confidence in the way they meet the UCITS requirements and implement the appropriate risk controls. With the independent supervision, passporting requirements, daily VaR analysis, trade compliance, appropriate regulatory oversight and a robust operational infrastructure it is little wonder that many possible UCITS candidates have decided to leave the UCITS playing fields to the big powerhouses in the scrum. Ironically it is these massive titans of the game that are also being courted by the bank platforms.
With the independent route to market being out of reach for the vast majority of participants, many are left scratching their heads as to how they could make a successful conversion. It is no secret that some of the more nimble, smaller players are often the most successful but how do they get on the pitch? The answer is the emergence of the independent UCITS platforms.
At Merchant Capital, we have built an offering which not only reduces the barriers to entry but was created with the underlying investor in mind, using our expertise to provide the necessary support mechanisms where managers may feel less comfortable. Following extensive due diligence and suitability testing, we have launched an additional two managers in the last three months and are in the process of launching another three. Having met with hundreds of managers since our launch in January 2010 we have an insight into where both managers and investors want to see the appropriate controls in place.
Corporate governance
Within a business model such as Merchant Capital’s, we are the investment manager, so it is our responsibility to ensure that all the necessary mechanisms are in place to manage a UCITS fund appropriately. As we appoint our clients to be the sub-manager, we allow them to focus on the generation of returns whilst we ensure that we are meeting the standards required by both the regulator and the investor. For example, with the advent of UCITS IV, it is Merchant’s responsibility to manage the migration with little or no impact on the client.
Pre-trade compliance
Many would classify this as an interesting subject for acute insomniacs only, but it is a vital pre-requisite for any fund looking to convince all classes of investor that the necessary controls are in place to ensure that breaches are not common-place. Post-trade compliance certainly serves a purpose, but at Merchant we believe that the preventative measure is much more important than a precautionary one. This is an area that may be as interesting as a snow report in the Bahamas for established offshore managers, but is again something that can be integrated efficiently by an independent platform with no deviation from normal trading activity.
Independence
From the conversations we have had to date, investors take great comfort in knowing that their interests are directly correlated with the risks the platform incurs in ensuring that their clients are meeting all the standards expected of them. It is not too bold a statement to say that companies such as Merchant carry as much or even more risk than the manager themselves in their role as investment manager, being accountable to both the regulator and the investor. It is therefore essential that the appropriate systems and controls are in place; if they are not, the manager will not grow, and one mistake will often lead to a loss of investor confidence that can take years to recover from. The independence of the platform provides an open architecture that allows clients to choose which counterparties to work with, e.g. swap providers, and therefore manage their costs more effectively.
Distribution
The term closest to every manager’s heart. If done correctly, the propensity for growth in UCITS is huge and platforms such as Merchant’s will work diligently to build an effective distribution programme that has every chance of success. Our first statement is that we do not believe that the standard internal cap intro model works, something offered by some other platforms. Quite often the same strategy is being introduced to the same investors with the only difference being that the fund is now within an onshore UCITS structure. Most of these institutional investors are sophisticated enough to not care whether the fund is onshore or offshore, and the vast majority of retail investor classes are ignored. Therefore, Merchant employs a different strategy providing a number of different possible outlets for each of our clients:-
• Merchant has a close working relationship with a number of distributors throughout Europe, each of which has a regional expertise. A local relationship in important countries such as Germany is always going to have more precedence than a call centre in London or Geneva.
• The platform will work to gain access to the important institutional investor platforms such as AllFunds.
• Merchant has recently been building a UK IFA business throughout the UK. This will provide a unique entry point into the retail community but one that has to be carefully managed.
To conclude, the role of the independent platform will be vital in the continued growth of the UCITS industry. Its place will be to provide investors with greater scope for choice whilst offering the necessary controls and helping managers gain access to an enormous opportunity that is still in its nascent stages of development for the alternative investment community.
