The scale of the mini-boom in Ucits hedge funds since the financial crisis is astonishing the investment industry. As the funds’ popularity surges, however, so do concerns about their prospects.
Assets under management in Ucits hedge funds have doubled to $70 billion (£59 billion) since February, according to Hedge Fund Research. The number of funds has tripled to 600.
Through Ucits funds, hedge fund managers can tap into demand from less sophisticated investors seeking both hedge-fund-type returns and the security of a defined regulatory structure. They can also access countries where investors’ access to hedge funds is more tightly limited, most notably Austria, France and Germany.
This has enabled them not only to expand their overall assets under management but also to regain assets lost during the crisis. Many non-Ucits hedge funds suffered in 2008 and 2009 because of unpredictable markets, illiquidity and lack of transparency and risk management.
“One of the main benefits of the Ucits structure is that alternative strategies can join the mainstream,” says Christopher Day, the director of Merchant Capital. “Managers are taking advantage of this structure in an environment where investors are looking for the risk/return benefits of well-managed alternative strategies within tighter and more transparent regulations.”
Investors are reassured by Ucits funds’ limited leverage, strict liquidity requirements, restricted types of underlying investments, increased transparency and tighter regulation. Many regard them as more attractive than traditional hedge funds. (article continues below)
Hedge fund managers have come under immense pressure to rebuild trust. PricewaterhouseCoopers (PwC) wrote in a report published last week – Hedge Fund Trust and Transparency: “Investors are requiring far higher standards of governance and more robust operations, combined with greater transparency into operational controls, investment portfolio construction and performance.”
Even some sophisticated institutional investors say they prefer the transparency and constraints associated with Ucits.
Yet not all Ucits hedge funds are relatively simple long/short equity funds. There are also macro, arbitrage and commodity vehicles. When strategies are complex and difficult to understand, there is a risk of mis-selling.
Regulators have grown sceptical about the merits of Ucits hedge funds. Andrew Crain, the manager of the Financial Services Authority’s alternative investments and asset management team, says that as the market for Ucits-type products with hedge fund attributes proliferates, there may be an increased risk of mis-selling or misunderstanding. “Structural differences between Ucits products and the underlying hedge funds they are attempting to replicate can also lead to differences in both risk and return characteristics,” he says.
Much of the mis-selling concern has centred on the value at risk (VaR) calculations that managers can use to determine the investments of a sophisticated Ucits fund, instead of using simple limits on leverage.
Ucits funds that use the so-called “commitment approach”, on the other hand, can have a gross exposure of no more than 200%.
Day says a properly managed fund would not use a single measure of risk. “VaR is an extremely useful tool to help managers. It should not be the sole tool in managing risk,” he adds.
Despite criticism from prominent risk managers – including Nicholas Nassim Taleb – the European Union has persisted in using VaR to calculate the exposure of a sophisticated Ucits fund and has continued to allow sophisticated Ucits to persist as a retail brand.
Crain, a contributor to the PwC report, says hedge fund managers should be sure that they will be able to “honour” the liquidity promises of Ucits funds. “They should also be careful not to market any fund strategies that are not in strict compliance with the Ucits rules and their spirit,” he adds.
The European Fund and Asset Management Association has also voiced concerns and has set up a working group.
In Britain, BlackRock, GLG, Cazenove, Jupiter and GAM are among the asset managers that have launched successful Ucits hedge funds.