One of the key issues regarding distribution of hedge funds in Europe concerns processing.
For traditional funds, the European market is extremely fragmented compared with the US, with no standardisation in terms of trade processing, trade instructions, cut-off, fees or, as yet, a harmonised standard prospectus.
However, there are signs that the harmonisation and standardisation of fund distribution processing are gradually being driven by the emergence of various platforms, including B2B platforms such as Vestima from Clearstream and Fundsettle from Euroclear, as well as very large local consolidators in Spain, Italy and Germany, and new developments from SWIFT.
However, the emergence of distribution platforms and moves toward standardisation concern Ucits and other regulated products, not hedge funds. Not only are hedge funds rarely seen on such platforms, but there seems little enthusiasm for developing them to process these kinds of product.
One of the consequences is that the processing of hedge fund distribution is extremely manual. It entails a lot of risks and errors, and the cost of processing hedge fund transactions remains still extremely high compared with standard Ucits.
Hedge fund processing cannot be packaged in the same way, it is less streamlined, and it's much more complicated. In addition, the administrators in charge of the shareholder register or fund accounting are often in the Cayman Islands or other exotic locations where technological capacities may be more limited than in Europe.
In addition, given the structure and risk profile of this kind of product, it evidently needs to be distributed together with a certain degree of advice. It is for more sophisticated and well-educated investors than the purchasers of traditional mutual funds.
A very important distribution channel for hedge funds consists of managers of funds of hedge funds. We are often asked by hedge fund managers whether we are able to introduce them to funds of hedge funds, to the extent that this can be considered an added value service on the part of the administrator. This can sometimes be a key factor in winning an administration outsourcing deal.
Distribution channels for hedge funds are also governed by the complexity of the product. We see much business from the high net worth clients of our private banking department, to the extent that we are looking at centralising the purchase of hedge funds on behalf of the various private banking entities of the group.
A new development involves moves toward retail distribution of hedge funds, or at least funds of hedge funds, in Germany, France and Italy. However, given the substantial risk surrounding the product, it will still be targeting the sophisticated end of the market and will require advice. Even with retailisation, it will not be possible to use traditional distribution channels where no advice is available.
In addition, the vast majority of hedge funds still have very high minimum initial subscriptions, which by definition keep out small retail investors. There is evidence from fund promoters that they are more open to retail investment than a few years ago, when funds were strictly reserved for institutional and/or high net worth investors, but a minimum investment of USD 500,000 is a very high entrance ticket.
If you lower the limits, as has happened in markets such as Hong Kong and Singapore, obviously you will see an increase in retail investment, although it will be a gradual process. Today hedge funds are a trend, and people love to follow a trend. In addition, there's more information available about hedge funds today.
Three or four years ago there were no specialist publications, just the occasional article. Today there are plenty of publications completely focused on hedge funds, so there is an information process that ultimately will favour the retail investor because it can help provide the kind of advice he is looking for.
But before we see hedge funds in fund supermarkets, there is a lot of work to do on transaction processing. Sometimes this involves completing a subscription form of 50 or 60 pages, highly detailed anti-money laundering and KYC reports, and a lot of compliance-related procedures. This means a great deal of complicated manual processing - in our industry everyone talks about straight-through processing, but there is absolutely no STP for hedge funds.
Retailisation will bring another change in terms of marketing and distribution. Fund of funds managers or sophisticated private investors either know who is behind a product or receive advice, but more retail investors will need to know the brand. This will favour well-known international institutions over small boutique players.