Hedge fund managers were never going to stay away from new distribution channels for long, especially ones with the promise of onshore distribution – historically the area they had been unable to access with their tax-efficient offshore fund structures and trading strategies deemed inappropriate for unsophisticated onshore investors. The convergence of hedge fund strategies and the Ucits regulatory structure have led to what have been termed Newcits.
The growth in hedge fund strategies offered through Ucits wrappers has grown significantly in the past 12 months, together with their assets under management. This growth has been driven by investors’ need for the much-debated diversifying properties of hedge fund strategies, delivered in a regulated investment structure by trusted providers (meaning with operational and financial stability), and the potential impact of the EU’s Alternative Investment Fund Manager Directive on the investment landscape.
Possibly the biggest draw card of Ucits funds for investors in hedge fund strategies is the perceived liquidity they offer.
There are caveats to this hedge fund distribution utopia. There is nervousness that investors are buying into a regulatory smokescreen and that sophisticated hedge fund strategies are being distributed to investors who may not fully grasp the strategies but believe they are protected by the regulator. Hence they feel they no longer need to understand fully the assets being traded and how they are being run by the manager.
EU supervisors are no doubt nervous, too, regarding the use of hedge fund indices and swaps as eligible assets in order to deliver hedge fund strategies that would ordinarily not be permitted or be too complicated to structure within Ucits products.
There is a feeling that investors are being blinded by the format used to deliver the strategy, and not taking enough care and due diligence when determining how suitable it is to their investment needs.
The Ucits brand has an excellent reputation for delivering products based on very strict criteria such as liquidity, leverage, credit and counterparty risk, and eligible asset definition. These might be a little burdensome and expensive to maintain, but Ucits delivers products across regulatory boundaries in an efficient manner – and this reputation needs to be maintained.
One of the most effective methods of marrying this regulatory framework with complex hedge fund strategies is to require any Ucits products based on alternative strategies to use managed accounts as the underlying basis for the investment.
Managed accounts are the only independent way of assuring the regulator that full transparency is available from an independent provider and that the asset eligibility criteria are adhered to completely. The perceived liquidity offered can be measured and any uncertainty over time to redemption of any asset in the portfolio can be stress-tested. Perceived liquidity could then be seen as certain liquidity.
A managed account infrastructure would deflect accusations that Newcits are nothing more than complex investment banking techniques and instruments that disguise the true nature of the products. Managed accounts are a cost-effective means of delivering certainty and transparency – independently.
The outlook for managed accounts has again been strengthened by the ease with which they provide simple solutions to complex regulatory frameworks. The architecture is ideal for alternative fund of funds managers to distribute their strategies onshore without having to resort to complex arrangement that raise alarm bells with investors, regulators and industry members alike.
Simon Hookway is managing partner of MAG Consultancy