Editor’s Letter – February | March 2015

Issue 102

HAMLIN LOVELL

"The Rise of Alternative UCITS” seminar was hosted by lawyers K&L Gates, in London this year, with The Hedge Fund Journal invited as a guest on the panel. In just two years, alternative UCITS assets have nearly doubled, from €138.6 billion in 2012 to €260 billion in 2014, as per the Alix Capital database. This is now 10% of global hedge fund industry assets of $3 trillion.

Advantages for investors and managers alike are well known. Investors are frustrated by the lack of diversification offered by traditional asset classes. The trillions of euros of government debt now on negative yields makes the clearest case for an absolute return approach: these bonds are guaranteed to lose money if held to maturity – but guaranteed to make money if shorted to maturity. In other asset classes, too, pickings have been richer on the short side, with oil and many metals collapsing in price in 2014. As well as de-correlated returns, investors like liquidity that ranges from daily to bi-monthly, and take comfort in controls such as depositary liability and oversight, diversification criteria, regulators’ veto over changes to investment objective, and a prohibition on sub-allocating to unregulated funds.

Managers are diversifying their investor bases by attracting types of investors that might be unable or unwilling to invest in traditional offshore hedge funds – including many outside Europe, in Asia and Latin America where brand recognition is strong. Minimums as low as €100 appeal to retail investors, but those UCITS requiring €100,000 or more can target high-net-worth, sophisticated and institutional investors. UCITS are one medium for transparency that can reduce Solvency II risk weightings for insurers. Long-only managers facing pressures on fees can often justify at least a performance fee, if not also higher management fees, for an absolute return launch, although the traditional 2 and 20 should not be taken for granted, particularly where UCITS investment restrictions – or manager choices – result in lower volatility than offshore siblings.

Yet plenty of UCITS now show minimal tracking error versus their unconstrained, and less extensively regulated, strategy peers. UCITS subject to value at risk (VaR) targets need not find their style is cramped by leverage caps, and K&L Gates partner, Sean Donovan-Smith, sees a wide suite of hedge fund strategies being adapted to UCITS. However, it is well understood that strategies seeking to earn illiquidity premiums don’t fit into UCITS, hence long-term infrastructure funds ended up as AIFs, not UCITS.

Currently, some UCITS obligations are less onerous than those applying to AIFs, finds K&L Gates special counsel, Andrew Massey – but he does expect UCITS rules will be aligned with AIFMD in some areas.