The growing proliferation of hedge funds in Ucits III structures has been partly driven by investors’ increased demand for higher liquidity, transparency and regulatory oversight, which so-called ‘Newcits’ supposedly offer more than their offshore or lightly regulated versions. After all, suspensions and gates imposed by hedge funds during the financial crisis and the Madoff fraud are still very fresh in people’s minds.
But ironically the risk is now that the Ucits stamp may lead selectors and distributors alike to lower their guard.
Reassurance
After the Madoff fraud, some of the largest hedge fund allocators in the world have decided to use Ucits III vehicles to get the comfort and reassurance they needed, to be able to sit back and say “we have done their due diligence and risk management work”, says Marc Denogent, managing director at HFR Asset Management based in Zurich.
“People tend to forget that the Ucits vehicle is not different to any other vehicle, from a structural perspective. The safeguards that are being promoted by Ucits III don’t necessarily match up with the reality,” he says.
For example, Ucits III funds are required to offer at worst two-weekly liquidity, and at best daily liquidity, but there are increasing concerns that the liquidity of the underlying investments may not match the liquidity the Ucits structure is supposed to offer.
According to recent research from consultancy Strategic Insight, there are worries in the distribution community that hedge funds, driven by business pressures and uncertainties about the European Union’s impending Alternative Investment Managers Fund Directive – which may impose some restrictions on the marketing of offshore hedge funds to European investors – are offering strategies less suited to the Ucits format, which might not provide sufficient liquidity during times of stress.
“Your investments will only ever be as liquid as the actual instruments themselves. If the underlying assets that are held within the Ucits vehicle can’t be traded, it does not matter what their framework is,” warns Mr Denogent.
“If you look in the fine print of any Ucits III fund, you will see that they can basically suspend redemptions in case of market disruption events. Ucits III does not necessarily guarantee liquidity and it is not because of Ucits III that investors are necessarily going to be safer,” he adds.
The potential liquidity mismatch between what the European Ucits directive in theory guarantees and the underlying investments is the major risk to consider when investing in Newcits, believes Nicolas Campiche, head of Pictet Alternative Investments.
“There are already a number of institutions that are playing with fire, creating Ucits funds using quite sophisticated swap structures, which are not liquid enough,” he says, explaining that in the $8bn (€6.5bn)fund of hedge funds operation he heads there are no investments in Ucits compliant funds yet.
“We are still analysing this emerging industry. Ucits is a fantastic brand name but it may be misleading to a number of investors, as to what the real risks embedded in a Ucits hedge fund are,” says Mr Campiche.
“We like to invest in products that have been tested over time and many Newcits are coming out just as an answer to some of the problems that were raised during the crisis. Should we decide to move in that direction, we will do so very carefully,” he says, explaining that, nevertheless, client demand is something to take into account and regulated long short or CTAs, which are the only two strategies that can really be successfully replicated in Ucits, can enhance liquidity in a fund of funds portfolio.
“There are only around 40 “real” Newcits hedge funds available and the only way to analyse them is very much through qualitative due diligence, because there is no track record yet,” says Mr Campiche.
Hedge Fund Research estimates there are now 400 Ucits compliant funds launched by hedge fund managers available on the market, which have gathered more than $35bn (€28bn). These include both regulated versions of existing hedge funds (Newcits) as well as new Ucits funds. Most of the strategies are predominantly in the equity long short space, which is the most conducive to the Ucits structure (see chart).
Also, there are some concerns that hedge fund houses are failing to meet the levels of transparency offered by traditional fund houses, including basics such as prospectuses, legal documents and details of performance, according to Strategic Insight.
“There seems to be full security that just because the fund is Ucits, it has much better risk management, transparency, and reporting than your offshore counterparts, but I don’t think this is necessarily the case,” says Ana Haurie, group managing director at marketing and distribution group Dexion Capital.
