The overall evaluation of the Italian alternative investment market is positive. At the same time, the following negative factors have been identified:
Legal framework: having mainly expressed a positive opinion on the effects of regulation on the Italian hedge funds market, the companies interviewed have not hesitated to point out that the legal subscription limits (€500,000) and 'cultural' aversion by investors to risk are a limiting factor for the diffusion of Speculative funds in the Italian market.
Competitiveness: in terms of competitiveness and development, the absence of specialist onshore knowledge is considered as a hindrance to the use of Italian funds offshore. The respondents note the lack of 'quality' newcomers to the Italian marketplace in terms of expertise. This inevitably limits competition in the market. The increase of onshore ability and skills would, in fact, enable the increase in interest from foreign markets which in turn would promote the entry of new, independent managers.
Putting things in perspective: the anticipated development trend is measurable only in the medium/long term period. Within this time frame the following relative provisions should be noted:
General picture: the respondents consider that current national legislation provides an adequate level of investor protection. They noted the strain on the market due to current investor perceptions, partly due to terminology; some of the proposed solutions highlight the absolute necessity to amend the name 'speculative funds', so as to highlight, rather, the hedging nature of the funds.
Identification: the perception needs to be changed by differentiating between pure fund (single manager) and funds of funds (multi-manager). Currently, funds of hedge funds are erroneously regarded as highly risky due to their categorisation as speculative funds.
Non-harmonised funds: the opinions are conflicting in regard to the new provisions introduced by the Bank of Italy in relation to non-harmonised open funds, which can invest up to 20% into speculative funds:
Generally the companies consider that it would have been preferable to face the problem of the splitting of quotas of speculative funds, i.e. clearly differentiating between single fund and funds of funds investments.
Actual picture: the absence of the fast and efficient development of a domestic single manager hedge fund market is due to exogenous and endogenous factors.
Exogenous factors: (i) existence of barriers due to cultural perception, thus acceptance of single manager funds; (ii) lack of requests from institutional investors; (iii) absence of appropriate management ability; (iv) rigid regulation; (v) mechanisms of taxation.
Endogenous factors: (i) difficulty in outlining, from a legislative point of view, the administrator/prime broker relationship; (ii) highest level of diversification guaranteed by the funds of funds; (iii) extremely onerous establishment costs of the speculative SGR; (iv) the benchmark culture that has limited the creativity of managers, and that has not motivated the entrepreneurial profile of this type of investment.
Putting things into perspective, the key factors that can determine future growth of the hedge fund market in Italy are numerous. The companies have, in particular, set out the following:
Limits on the number of participants (200): it is considered, by all respondents, inadequate and easily avoidable. Such constraints actually generate extra costs for SGR, thus reducing returns for investors.
Minimum investment threshold: the companies agree that such a threshold is not necessary in regard to funds of funds investment. Moreover, such provisions do not offer sufficient protection to the investors; the threshold does not in fact guarantee that the client is diversifying its investment (and that it is not investing all wealth in a single product).
Splitting prohibition of quotas: the common opinion of the respondents is that the splitting prohibition should be eliminated.
Solicitation prohibition: those participants that consider that it is appropriate to revise the solicitation prohibition comment that the prohibition limits investor education on such products. Alternatively, an solicitation prohibition could be measured on the characteristics of the investors. The companies propose, moreover, to "replace" the prohibition with the provision of greater informative obligations on the risks of hedge fund investment.
From 1999 to date, the Italian hedge funds market has recorded exponential growth, both in terms of the number of speculative funds and dedicated SGR. Nevertheless, this still represents a niche sector with respect to the most traditional forms of collective portfolio management and, if considered on an international level, the relevant dimensions are still of very small significance.
In only a few years since its commencement, one can evaluate the Italian hedge fund industry very positively. The participants have highlighted how the hedge fund market in Italy still offers great opportunities despite certain legislative barriers. The key reason is that, to date, these funds have been of interest to high net worth individuals, and not to the institutional and retail market yet.
The following points were given by participants as an indication of positive market development:
At the same time the following negative factors were identified:
However, despite the market having noted a temporary slowdown phase, the common view is that the market is undergoing a consolidation phase, continuing to provide strong products and strategy innovation.
Italy boasts one of the most complete hedge fund regulatory regimes, following the introduction of the note provisions relating to the Bank of Italy's Regulation of 14 April 2005.
Opinions on this topic are conflicting – on the one hand, the new provisions are seen as an opportunity for further growth of speculative funds through the shield of non-harmonised funds (a category of funds that can invest up to 20% of its assets into speculative funds). In particular, significant benefits are identified in terms of opening the retail market: the diversification of retail channels for such investments should increase appetite by the potential market, which will lead to a positive impact on assets under management. Also, participants are keen that retail access to these types of products is provided through the asset management companies.
On the other hand, there seems to be an opinion that underlines:
Participants note that it would have been preferable to face the problem of the splitting of quotas of speculative funds.
The new category of funds defined by the Bank of Italy's provisions, non-harmonised open funds that invest in speculative funds, seem to allow for a more widespread distribution of speculative products. The aggregate maximum limit of investment (20%) in speculative funds imposed by the provision is considered to be limiting. Such a limit reduces the impact that returns of the speculative product could have on the investor's portfolio. This would be particularly noticeable in downward trending markets.
Several participants in the survey pointed out that the operational challenges in connecting the "traditional" nature of the investment with the "speculative" nature of the funds. In particular, they noted the criticisms regarding the frequency of the NAV calculation: speculative funds usually have a monthly frequency, whereas the traditional funds have a daily or weekly frequency.
The Italian market is still characterised as a multi-manager hedge fund industry, waiting for the much hoped-for development of single manager hedge funds. The absence of a fast and efficient development of the domestic funds market is due to exogenous (environmental) and endogenous (investment management) factors.
Amongst the exogenous factors, the speculative funds' environment is influenced by a number, in particular:
Considered as whole, these issues contribute to rendering the Italian market less favourable than foreign markets, such as the UK and Switzerland.
Considering the endogenous factors, the interest is focused:
In relation to sub-paragraph (ii), it is noted that very often the managers of speculative funds need a sophisticated financial infrastructure as well as easy access to financial intermediaries and companies. Moreover, in relation to sub-paragraph (iv), it is noted that the management and structure of an ItalianSGR is more complex than an analogous foreign structure, in that it involves the absorption of greater capital, and a greater number of controls.
Recently, the legislator and the Supervisory Authority have demonstrated that they are prepared to halve the minimum threshold for participation in speculative funds and to double the maximum number of participants. Yet a number of participants want further legislative intervention in relation to this.
The participants believe that there should be a separate regulatory regime for single manager funds, and funds of hedge funds. This differentiation should operate, above all, in terms of thresholds and investment limits. There should be a lower threshold for funds of funds.
It is generally accepted that a minimum level of investment in a single manager speculative fund should remain higher, and that access to these funds should be confined to those investors that can prove a reasonable understanding of the product and its risks.
Relating to the minimum threshold of the investment, opinions are directed towards the adoption of an autorestriction mechanism by the managers of either single manager funds or funds of funds. They will be responsible for determining the appropriate capacity levels for their strategy/ies (instead of being limited by a minimum threshold) and determining when they close new investments into the fund.
The procedures set out by the market participants of the sector make it clear that the channels most in use for the research of their clients are either via the private banking group's structure, or an internal sales network. The private bankers act only upon specific written requests received from potential investors. Subject to production of the above mentioned request, they acquire materials from the SGR to be provided to the client.
Some participants hold one-to-one meetings, if the investors are not institutional investors; others meet exclusively with prospective clients being introduced by the company's shareholders and board directors.
During the preliminary phase of the investment, some companies will deliver to the prospective client explanatory brochures specifically created for this purpose.
In the early years of regulation, the Supervisory Authority excluded the possibility of indirectly investing into speculative funds through structured notes, social security, and insurance products. This continues to be subject to lively discussions, particularly in consideration of the significant evolution of the domestic hedge funds market, and of the ever more sophisticated and elaborate structures created and marketed by foreign 'competitors'.
With regard to structured product investment as an alternative to the direct subscription into speculative funds, some of the participants agree that such instruments provide an investment opportunity, useful for certain investors with particular needs. The characteristics of such products include: a principal guarantee, a possibility to invest in more alternative instruments, a possibility to employ leverage to increase investment returns, and the possible access to fiscal benefits.
In order to reach an objective evaluation of such products, it would be necessary to measure whether the value is in proportion to the costs. Some participants consider that the 'structuring' of such products could be helpful to carve out a more appropriate risk-yield profile for investors. Others consider, however, that the guaranteed principalstructure does not adapt well to speculative funds. This is due to the lower risk profile that speculative funds (specifically the funds of funds) already employ.
Attention must also be paid to the level of additional product fees for such a guarantee, when fees are already high for speculative funds, thus impacting returns.
It seems that no consistent reasons for prohibiting the distribution of such products exists. Even any potential methods of avoiding the restrictions to the splitting of speculative funds' quotas in order to distribute funds to retail clients could make sense. In fact, eventually such products will be totally different from any speculative funds, given the fact that they employ a much lower amount of risk.
Moreover, with particular reference to insurance products that have underlying foreign hedge funds, the participants expressed a negative opinion, noting that often these underlying funds are less regulated than Italian speculative funds. In particular, the main concerns surround 'non European' target funds, where it is impossible to rely on a uniform level of regulation.
There is a great deal of different of opinion in relation to the fact that structured products could provide a valid alternative to the subscription quotas of speculative funds. It is also noted that while a structured product could be an appropriate non-traditional financial vehicle, it is burdened by costs. Additionally, the underlying speculative fund should have liquid characteristics. In terms of perception, certainly, prospective investors seem to consider that such products are less of a risk.
The structure of alternative CPPI products (Constant Proportion Portfolio Insurance) or zero coupon with options, is more preferable to participants. These products deal with construction financing that guarantees principal protection. Nevertheless, some of the respondents have indicated that the kind of structure for such products depends on the risk-return objectives. Therefore, the specific structure should meet the range of client needs and should not be assumed beforehand.
Some of the participants have expressed the need to amend the provisions on structured products so as to permit the 'construction' of structured products indexed to speculative Italian funds and which can be subscribed to by retail clients. The need to strengthen the transparency obligations in regard to the risks and costs has been recognised, enabling the client or his advisor to evaluate the additional value of the product.
A further requirement which was strongly voiced was the need to avoid 'legal arbitrage'. This means removing the prohibition on distributing structured products; today, such products can be sold from a number of foreign markets, thus creating a competitive disadvantage for Italian managers.
The relationship between SGR and other entities involved in the management of speculative funds remains a delicate factor in the regulatory equation, with there being a strong need to leave ample space to manager autonomy.
Entrusting the NAV calculation to the custodian bank is considered to be the best solution by the majority of speculative fund market participants, even if these participants adopt different solutions. The main advantage of entrusting such tasks to the custodian bank is the existence of an independent third party required to carry out the calculation. In compliance with international market practice, such a mechanism would guarantee greater transparency and fewer conflicts of interest as security for investors.
Some consider that there are not enough advantages to the investors for this to be the preferred solution, though it does bring more organisationalflexibility for the managers.
The negative aspects of this arrangement are:
The participants have described different solutions adopted in order to calculate the Net Asset Value (NAV):
Some feel that outsourcing the calculation of the NAV could bring a slight increase in the cost structure of the fund; such increase could be avoided only through reduction of the management fees.