In Europe, the landscape for alternative funds is due to become even more differentiated later this year with the adoption of the Alternative Investment Fund Manager’s Directive and its coming into force in 2013 (see Fig.1). It will see funds register onshore (for example, a Qualified Investment Fund in Ireland or Specialized Investment Fund in Luxembourg), while remaining less prescriptive than UCITS on how funds can invest, leverage, liquidity and diversification rules.
RBC Dexia has positioned itself to help hedge fund managers adapt cross-border distribution and domiciliation strategies for alternative UCITS funds, or from July 2012, provide the same service for firms seeking to come under the purview of the AIFMD. For some funds the process will be relatively straightforward, for others it will prove more of a challenge.
Ready to assist
Thus, it is just as well that a broad-based international banking group like RBC Dexia Investor Services has positioned itself to not only provide custody and administration services, but also help with the transition of an offshore hedge fund into a competitive onshore strategy. Whether managers choose to opt for a UCITS or an AIFMD product, RBC Dexia is well placed to assist and provide advice.
“That is why our strategy at RBC Dexia is to provide alternative UCITS as well as services to funds setting up under the AIFMD,” says Olivier Laurent, who is RBC Dexia’s Director of Alternative Investments Management Products. “The key benefit of setting up under AIFMD is less constraint on the diversification of assets. Managers can also invest in asset-backed securities and distressed asset strategies.”
In some respects, a fund set up under AIFMD is more closely akin to a typical offshore fund than a UCITS product. Under AIFMD, funds don’t have to use derivatives to short stocks in a long/short equity strategy for example or to leverage a position on bonds in a credit arbitrage strategy as is done with a UCITS fund. Also, like an offshore fund, an AIFMD-compliant fund will be able to use an active prime broker with more flexibility to scale up position concentrations and use leverage, even though position changes in both these areas will need full disclosure.
“It is difficult to say how many hedge fund managers will decide to move from an alternative UCITS to a regulated fund, but it is unlikely to be many,” says Laurent. “But for those managers who have yet to set up an alternative UCITS or a QIF or SIF it will not be an easy decision.”
For now, the main focus at RBC Dexia is servicing alternative fund providers seeking to access European investors. For example, the firm is targeting US fund managers where interest has been steadily rising over the past 18 months. It is also finding some interest in Canada for developing UCITS to market to an international investment audience beyond their core North American investors.
Types of asset manager clients
RBC Dexia is seeing three types of asset manager client emerge. Each one may share a similar ambition to launch a UCITS. What’s different is the level of support different asset managers may require.
One category of asset manager client is attracted to a fully fledged UCITS platform provider. Such a provider will offer a suite of capital introduction, execution, derivatives and middle-office services to the full range of different hedge fund strategies on a particular platform. This might even extend to managed account services. In the case of the Lyxor Managed Account Platform, RBC Dexia serves as the transfer agent. RBC Dexia can also provide pertinent guidance on specific strategies.
“We have a good relationship with the regulators and give advice to clients from that background,” says Laurent. With a team of over 50 dedicated to alternative UCITS, RBC Dexia has the resources and expertise to process a heavy volume of trades, while also having the ability to handle the complex derivatives transactions used in total return swap calculations. Laurent cites DB Platinum IV dbX Systematic Alpha (a leading managed futures strategy advised by Winton Capital) as an example of the sophisticated accounting and derivatives processes that RBC Dexia has developed in association with Deutsche Bank for an alternative UCITS fund.
Global asset managers
The second type of investment client for UCITS administration and custody services are the global asset managers. This might include firms like Swiss & Global, Dexia Asset Management or HSBC. These asset managers have substantial long only products but want to diversify their range of products by launching alternative UCITS on the full spectrum of hedge fund strategies.
“Here we see strong growth,” says Laurent, adding that the funds from these providers can usually be sold to institutional or retail investors. But RBC Dexia is careful about discharging its responsibilities. As custodian of the fund, RBC Dexia has to approve sub custodians. It also wants to ensure a smooth process when these asset managers invest in emerging countries where custodian terms can differ a great deal.
The third type of UCITS client is the traditional or boutique hedge fund manager. Here RBC Dexia has recently added five new clients, including three in Europe and two in the US. The assets under management for such funds typically range from $50 million to $1 billion. Here the assistance of RBC Dexia is invaluable since the demands for a fund to set up in a UCITS are quite different from what a hedge fund will be familiar with in the offshore sector. For the fund manager, a key factor in going with RBC Dexia is speed to market. To get regulatory approvals and set up the management company can take up to a year for an asset manager acting independently. By bringing in RBC Dexia an asset manager should be able to get a UCITS fund on-boarded and open to investor allocations in less than six months.
“When we have meetings with a hedge fund manager we often see that they are used to having everything done for them by a prime broker,” says Laurent. “It means that custody, settlement and NAVs were managed by the prime broker who may have referred the administrator to be used for striking the NAV. With UCITS you have to select your custodian, the European management company and choose the counterparties for contracts for difference and sign agreements for collateral management. It is a pretty lengthy and detailed process that a hedge fund setting up an alternative UCITS may not wish to do on its own.”
Risk management procedures
Laurent would advise a hedge fund firm that if the aim is to set up a regulated hedge fund, but the amount of money that may be raised is uncertain, then it is best to launch a UCITS under a platform. Conversely, if the hedge manager wants to set a range of alternatives UCITS with a good vision of the amounts raised, the direct way is better. But he notes that finding a management company and getting the appropriate risk management procedures right all take time.
Despite the UCITS sector’s relative novelty for alternative funds, on several key measures it is performing solidly. This record is paving the way for new investors to allocate capital to UCITS and is encouraging hedge funds, notably in the US in recent times, to set up additional strategies. The growth in fund launches wasn’t as rapid in 2011 as in earlier years, but new managers continue to consider how a UCITS fund may offer a growth stream to their businesses.
How big an impact UCITS may have on what fund managers do with new launches remains an open question. Data from funds in the sector is growing as recently started offerings have more time to produce performance. Two features of the UCITS Hedge Index stand out. One is that performance lags offshore funds which have less constrained mandates in terms of position size, leverage and liquidity terms. The second feature is that volatility is much lower.
Many analysts predicted that the performance of UCITS would likely suffer from extreme tracking error between existing offshore and new onshore strategies. Laurent says this hasn’t proven to be a serious problem, and the odd instance where it has cropped up remain isolated cases.
Daily dealing is UCITS norm
Another area where analysts feared UCITS might run into trouble was with liquidity. Though UCITS funds must offer a minimum of fortnightly liquidity, the majority of funds are offering investors daily dealing. The fall off in liquidity, especially pronounced at different times during 2008-11, might have been expected to have had a highly negative impact on UCITS. But what actually happened was different.
“During the last quarter of 2011 we have not seen any significant problems in the UCITS area,” says Laurent. “There has been no tsunami of investors wanting money back. Funds have been able to honour redemptions. Some concerns will remain, but so far alternative UCITS have shown they can work well with daily liquidity.”
With alternative UCITS performance gaining traction and liquidity proving feasible (and popular with investors), another popular aspect of the structure is its transparency. This has been augmented with Key Investor Information Documents. The so-called KIID, which RBC Dexia helps funds complete, provide a comprehensive yet short-form summary of expected performance and volatility of a fund, while documenting counterparty risk and summarising the key points of the investment strategy.
“What we have seen from asset managers is a determination to demonstrate a clear separation of functions,” says Laurent. “This can include pricing OTC items independently.”
He adds that alternative UCITS also face the challenge of setting up a strong process for collateral management. In September 2011 this became more onerous with investment banks required to post 100% of collateral for a fund’s position compared with 20% earlier.
“For the prime brokers run by investment banks, it means they have to post cash or securities of good quality,” says Laurent. “They can’t re-hypothecate all assets transferred by the funds. This is having a positive impact for UCITS investors. “If a counterparty defaults – because they have had to post 100% of their exposure – it will be much easier for investors to get the assets back. There is also a reduction in operational risk in having the custodian separate from the prime broker.”
He adds: “What we are seeing is more transparency in the UCITS strategy and the collateral management. With over 700 alternative UCITS, choosing the right strategy is easier for investors. KIID is also helping this to happen much more easily. Compared with offshore funds, the proposition, strategy and value claim is much easier to understand with UCITS.”
UCITS also incorporate some built in distribution options not available to offshore funds. For its part, RBC Dexia distribute UCITS to over 15 countries across Europe, but also in Asia and South America. Using RBC Dexia’s distribution platform gives managers access to a near-global investor base and means a fund needn’t be obliged to distribute via separate private placements or unsolicited approach in each country where marketing is undertaken.
“I think flagship US funds will go their own way to access EU investors,” says Laurent. “But the bulk of funds will want to be able to market to European and Asian investors and that will mean complying with EU regulation. The transparency and separation of functions in the AIFMD provides benefits for investors and managers. It will be the European passport. A fund only needs to be accepted in one European state to be marketed in all the others. With AIFMD, the rules will have to be consistent from country to country. We don’t expect it to be a transition regime.”
Director, Alternative Investments Product Management
Olivier joined RBC Dexia in September 2004 as Head of the Hedge and Structured funds team, in charge of the development and implementation of solutions for hedge funds, funds of hedge funds and OTC derivatives products. Prior to joining RBC Dexia, Olivier spent two years analyzing structured credit operations for IXIS corporate Investment bank in New York, three years as risk manager on OTC derivatives and credit hedge funds transactions and four years as a risk analyst in a French asset management company.
Director, Business Development, Alternative Investments
José Santamaria is Director, Business Development for RBC Dexia Investor Services. Based in Luxembourg,José is responsible for securing new business relationships in the alternative investments market. José comes to RBC Dexia from RBC Global Private Banking, where he was Head of Institutional Sales and Business Development. He joined Global Private Banking in 2000 to oversee fund administration in the Channel Islands. Previously, José worked with RBC Global Services, starting in 1997 as Director of Fund Services. In this role, José helped set up the offshore service model for the Americas (Canada, USA and Latin America). Prior to joining RBC, José was Manager of Fund Operations at both National Trust Company and Canada Trust Company.