Ireland is seeing the establishment of an increasing number of ‘Newcits’ – Ucits funds that pursue alternative investment strategies. Hedge fund managers are interested in Ucits because it is a means to regain assets from high net worth private banking clients and institutions that have not yet returned to alternative investments and that place greater emphasis on liquidity, transparency and regulatory protection.
Ucits is a pan-European fund product that, once established in Ireland, can be sold cross-border within the European Union or European Economic Area under a harmonised legislative framework without any requirement for additional authorisation. The recently adopted Ucits IV Directive, which is expected to be implemented into Irish law before July 2011, will dramatically simplify the cross-border notification process within the EU and EEA.
In addition, Ucits is a global brand recognised worldwide as a robust, well-regulated product attracting investment not only from within the EU but from a wide range of outside markets. For example, Hong Kong, Japan, Taiwan and many South American jurisdictions, as well as non-EU European countries such as Switzerland readily accept Ucits for inward sale.
Finally, the Ucits structure can facilitate many alternative strategies, and it is a welcome alternative given the uncertainty over the EU’s proposed Alternative Investment Fund Managers Directive.
The continued strength of interest in Ucits is evident. According to the European Fund and Asset Management Association, Ucits enjoyed net inflows of EUR51.7bn in the first quarter of 2010. At the end of May, Ucits accounted for 76 per cent of the total European fund market, with net assets of EUR5,517bn.
Currently there is more interest in establishing single Ucits hedge funds than Ucits funds of hedge funds, principally because managers consider the current Ucits hedge fund universe too narrow.
The vast majority of hedge fund Ucits strategies are long/short equity, long/short credit and global macro, whereas some strategies with the highest potential returns, such as distressed securities and convertible arbitrage, are difficult to transpose within a Ucits because of liquidity and leverage constraints.
However, it is possible to gain exposure synthetically to a greater variety of strategies, for example through a total return swap covering an index of hedge funds, provided the index meets certain regulatory criteria.
Although Ucits hedge fund products are expected to underperform their equivalent offshore funds because of investment and implementation challenges of the regime such as issuer concentration rules, liquidity and eligible assets requirements, hedge fund managers are still interested in establishing Ucits because of their distribution potential.
From a distribution perspective, Ucits are viewed as more attractive than offshore funds. One reason is increased liquidity – Ucits are required to provide for the redemption of shares at least twice a month. They also offer greater transparency through the publication of annual audited and semi-annual unaudited accounts.
Regarding regulatory oversight, all assets must be held for safekeeping by an independent custodian, which must ensure legal separation of non-cash assets held under custody. In addition, a Ucits must provide on request supplementary information to investors about the risk management methods employed.
Given the distribution potential and the advantages of a Ucits product, the Newcits trend is expected to continue.
Brian Kelliher is a partner in the asset management and investment funds unit of Dillon Eustace in Dublin