Regulated funds meet client expectations

Hedge fund groups are increasingly moving into the regulated fund arena to broaden their investor base and attract more assets. The widespread suspension of redemptions across much of the industry and the lack of external oversight and custody exposed by the Madoff affair last year, has undoubtedly affected investors’ perception of these alternative instruments. Indeed, large hedge fund managers are launching strategies in the Ucits III structure, which allows the use of a certain amount of leverage and synthetic shorting, to meet client demand for more liquidity, transparency and regulation oversight. Feeling safe Ucits funds, designed for pan-European distribution, are now also becoming very popular in many Asian and Latin America countries, as investors and regulators become more and more comfortable with Ucits’ built-in safeguards. The relative attractiveness of Ucits for offshore hedge fund managers has also increased in light of the potentially onerous burdens that may be imposed, if the proposed alternative investment fund management (AIFM) directive were to become law in something like its current form. The current lack of certainty regarding the directive and the potential effects it may have on the hedge fund industry is leading managers to establish Ucits III funds, explains Mr Jerome de Lavenère Lussan, managing director at regulatory and legal consultancy firm Laven Partners. “In the past few weeks we have seen an increasing number of clients who want to set up Ucits III funds or are thinking about it,” he says. “If you are an entrepreneur and you want to stay a step ahead in the business, you feel that you should set up a Ucits III vehicle, to gain investors’ trust, and get money back again,” says Mr Lussan. Alternative asset manager Man Investments recently announced the launch of two Ucits III funds, called Man AHL Diversity, aimed at UK sophisticated investors, and Man AHL Trend aimed at European sophisticated investors. The products give access in a regulated format to a highly liquid portfolio of futures and forward instruments that are trend following the global markets; they are both managed by AHL, a division of Man Group and one of the largest trend-following – or managed futures – managers in the world, with $20bn (E13.5bn) of assets under management. The firm decided to launch these products to build on its 20 year track-record of its hedge fund strategy, which, being very liquid, lends itself to the Ucits III structure. “For many years, private investors all around the world have enjoyed the returns and low correlation to traditional asset classes offered by AHL,” explains Harry Skaliotis, investment manager at AHL. “Our funds were up anywhere from 25 to over 30 per cent in 2008 and really delivered on that promise of being able to generate uncorrelated returns. We focus our trading on the most highly liquid futures and forward markets, we can trade in and out of these markets opportunistically and cheaply and we can go long and short with equal ease,” explains Mr Skaliotis. New channels “We see these Ucits III products as a progression in terms of making AHL more widely available to investors,” states James Jacklin, regional sales manager Europe for Man. “Ucits does clearly open up new distribution channels and we are widening the reach, in that there will be people who will buy Ucits funds but won’t buy an offshore hedge fund,” he says. “We feel that there is a demand for liquid, transparent products, and Ucits gives wealth managers some comfort that the product is within an onshore regulatory framework.” Mr Jacklin anticipates that the firm will probably offer more Ucits products in other strategies in the future, but no specific plans have been made yet. “We expect significant flows through the Ucits route,” he says. It is important to make sure that the performance of the product delivered in the Ucits III wrapper is the same as that of the offshore product, emphasises Mr Jacklin. “We created Ucits III products which replicate the offshore fund onshore, less the cost of the Ucits wrap, which is marginal. It is very important to us that our investors get the same type of portfolio and performance that they will get if they are investing offshore,” he says. The AIFM directive has not been a driver at all in the firm’s decision to launch regulated products, says Mr Skaliotis, explaining that AHL already offers onshore products in other jurisdictions, including Hong Kong, where their onshore fund has gathered $2bn. Increasing convergence Further evidence of the increasing convergence of hedge fund strategies and the Ucits structure is given by the recent announcement made by Bank of America Merrill Lynch to launch 12 more retail hedge funds by the end of 2010, on top of its York Event-Driven Ucits Fund launched in July this year. The bank’s target is to have around 15 funds (and at least $2bn) in assets under management from its Ucits-compliant Luxembourg Sicav, explains Eric Personne, Emea head of the fund solutions group at Bank of America. The bank is looking for best-in-class hedge fund managers that would benefit from Merrill’s structuring and distribution capabilities, he says. The launch of the York Event-Driven Ucits Fund, which offers York Capital Management’s event-driven strategies as part of the bank’s Ucits III platform, followed two previous launches made by the bank in this area: the Marshall Wace Tops Ucits, managed by London-based hedge fund Marshall Wace, which was launched in 2007, and the BlueTrend Ucits Fund, which is a Ucits-compliant version of the trend-following BlueTrend CTA strategy run by BlueCrest since April 2004. Adding to the list, Collins Stewart, a London-based financial advisory group, recently announced its plans to launch a fund of funds within the Ucits structure. Schroders too says that it is working with hedge fund managers to launch a range of Ucits funds for sophisticated investors. “We want to identify strong hedge fund managers whose strategy can be implemented within Ucits rules,” says Gavin Ralston, global head of product at Schroders. “This should give much greater confidence to clients that can take advantage of the underlying strategies without some of the risks that hedge fund investing has traditionally had. It is a way to democratising hedge fund investing.” However, there are limits to the degree to which hedge funds and Ucits vehicles can converge. The Ucits framework restricts managers from making very illiquid investments that are most difficult to value and that rely mainly on leverage, which define some of the most popular types of hedge fund investments. “Hedge fund managers have been sitting on Ucits III products for over two years and there are a few more being established now, but it is a modest trend, it is not something that most managers would even contemplate doing,” believes David Butler, founding member of hedge fund consultancy Kinetic Partners. Most hedge fund managers are not interested in setting up Ucits III funds, either because their strategy does not lend itself to the Ucits III structure or because they are not looking for a wider range of investors. Also importantly, launching Ucits III funds requires an institutional grade infrastructure that not all hedge fund managers have. “The launch of Ucits III funds will be probably limited to larger players, mainly, who have institutional grade operating platform,” he says. Mr Butler points out that a lot of changes are happening in the industry in terms of what constitutes “best practice”. With many good best practice standards being set up, such as the one from trade association AIMA (Alternative Investment Management Association), there is really no need for a hedge fund manager that follows best practice to launch Ucits III funds, just to reassure investors. Room for both Gavin Rankin, head of advisory at UBS Wealth Management in London believes that there are opportunities for both types of vehicles. In particular a large part of the appetite for Ucits III structures is likely to be tax driven in the UK, as it is expected that from April next year, high net worth investors will have to pay 50 per cent tax on the returns generated by offshore hedge funds, “which is clearly unattractive”. “UK high net worth investors are going to have a preference for Ucits structures, which, if they have reporting status, will be subject to 18 per cent tax on capital gains,” says Mr Rankin. Looking forward, the expectation is that the cross-border and operational benefits coming from the updated 2009 Ucits Directive, or Ucits IV, will attract increased interest from other alternative investment managers over the coming years. “I think hedge fund managers are hoping for Ucits IV,” says consultant Mr Lussan. “In the meanwhile they will launch products in Ucits III and they will probably keep their offshore funds as well. We will see both vehicles because investors’ needs are on both sides of the fence.”