In many ways, this is just the first stage of growth for alternative UCITS. There is still a huge amount of future growth potential yet to be realised. If one looks at the supply/demand dynamics for UCITS, there are roughly USD9 trillion invested in UCITS products, 30,000 funds and only 800 alternative UCITS with approximately USD350 billion in AUM; a fraction of the total AUM.
From an opportunity perspective, only 3.8 per cent of UCITS AUM is in alternatives. Even if investors only move 2 per cent of their traditional long-only capital in to alternative UCITS, that would represent USD200 billion of new assets. If their allocation moved to 10 per cent it would take the alternative UCITS industry to USD1 trillion.
As reported towards the end of last year by Preqin, 35 per cent of the more than 100 investors surveyed in June said that they currently invest in liquid alternatives; either alternative UCITS or ’40 Act funds. A further 16 per cent said that they planned to in the future.
The quality of alternative UCITS, generally speaking, is improving, as more hedge funds decide that if they want to participate in the European market they need to seriously consider having a UCITS structure.
This is proving highly beneficial to Europe’s key fund jurisdictions – namely Ireland and Luxembourg, both of whom are seeing substantial traction for UCITS products. Over the last five years, Ireland has experienced an 81 per cent growth in UCITS funds, which, according to the Central Bank of Ireland figures, as of September 2017, total EUR1.77 trillion in AUM.
Last year USD30 billion of net new business went into alternative UCITS, this was dominated in particular by very strong flows into multi-asset absolute return funds. This year, says Andrew Dreaneen, Head of Liquid Alternatives, Schroders, there have been continued inflows. “Alternative risk premia strategies continue to be of interest, and one or two large fixed income houses have been raising a lot of money for UCITS income-oriented unconstrained fixed income funds, which continue to be very popular,” says Dreaneen.
Kepler Partners publishes a quarterly review on the alternative UCITS market. It currently tracks 569 funds managing GBP284 billion. In total, there were 19 new launches in Q3, which collectively raised GBP485 million in assets. The report notes that both Multi Strategy and Event Driven strategies have been particularly popular this year, with much of the growth in the Multi Strategy space coming from risk premia focused products; echoing Dreaneen’s comment.
The largest launch in Q3 was the Winton Diversified Fund (UCITS), which raised GBP148 million, followed by Prime Capital Multi Advisors UCITS with GBP106 million. Over the last 12 months, the three biggest fund launches have been: AQR Systematic Total Return UCITS (GBP368 million), MLIS Milburn Diversified UCITS (GBP179 million) and CZ Absolute Alpha UCITS Strategy (GBP163 million).
This is interesting for the fact that all three are prominent hedge fund managers, in a space that is characteristically associated with traditional asset management houses.
“CZ Capital launched their fund in June 2017 and it has effectively doubled the firm’s total AUM. The UCITS fund now has USD290 million. Prior to this, CZ was running USD340 million in total,” comments Georg Reutter, Managing Partner, Kepler Partners LLP. He says that over the past year, Kepler has tracked a total of 68 new launches in its database, raising in excess of GBP3.3 billion combined.
“The AQR launch was substantial, it was very timely,” adds Dreaneen. “It’s clearly something they’ve had a lot of success with in other structures – Cayman, US ’40 Act – as have other big name managers such as Two Sigma, which joined GAIA last year.
“We’ve hard closed three of the seven funds on GAIA. Two Sigma raised just over USD1.5 billion in five months, which is a record for the platform. The other two funds are Schroder GAIA Egerton Equity and Schroder GAIA Cat Bond. Investors can fill out an expression of interest form to apply for future capacity. We have a significant amount of pent-up demand for these products.”
Reassuringly, alternative UCITS have had a decent year, performance-wise, in 2017. The AH Equity Long/Short Index is up 6.4 per cent YTD, while the AH Multi Asset Index is up 5.5 per cent.
“Performance has been decent and there’s been some good launch activity but it hasn’t been a ‘wow’ year. Equity long/short funds have done well, particularly those with exposure to Emerging Markets and China. Out of the top five funds, performance wise, two have China in the fund name; the best performing fund, year-to-date, is the BANOR SICAV Greater China Long Short Equity Fund, which is up 55.7 per cent.
“Across our total funds universe, the top 10 funds are all equity long/short funds, all of which are up by more than 20 per cent. The majority of these are emerging markets funds,” explains Reutter.
Dreaneen confirms that the best performing fund on GAIA in 2017, up 21 per cent, was the Indus PacifiChoice fund, a pan-Asian equity long/short fund. The best performing fund in Schroders’ internally managed stable of liquid alternative funds was the Schroder ISF Asian Total Return fund, up 38 per cent.
“It was a great year in the industry for emerging market long/short funds. Several of the top 20 best performing hedge funds are either EM, China or India long short funds, several of which were up more than 40 per cent,” says Dreaneen.
Dispersion is at its widest point in quite a long time, which makes for a better environment for stock pickers and active managers. The number of active managers outperforming their benchmarks is 52 per cent, according to Dreaneen (https://www.ft.com/content/150bfb14-a848-11e7-93c5-648314d2c72c), considerably higher than previous years when that figure was as low as 10 to 20 per cent.
Generally speaking, correlation between UCITS funds and offshore counterparts has been getting closer. According to Ed Morse, Sales and Marketing Director at Tages Capital, a leading alternative investment specialist, for highly liquid strategies there is no real reason why a UCITS fund should not perform, with a very close correlation, to its offshore counterpart.
“UCITS tend to be daily or weekly liquidity, whereas most offshore funds are monthly liquidity or longer. That means offshore funds can invest in less liquid stocks, for example, which may add extra alpha, relative to a UCITS fund. Broadly speaking, correlations are very close for liquid strategies such as equity long/short and CTAs,” says Morse.
UCITS platforms seizing the opportunity
Prominent asset managers, such as Lyxor Asset Management, see long-term value in alternative UCITS and consider them an important revenue driver as managers look to develop global distribution strategies, combining both onshore and offshore versions of their strategies.
Four years ago, the bulk of Lyxor’s business centred on offshore commingled funds. Nowadays, says Daniele Spada, Head of Lyxor MAP, Lyxor has moved to a larger range of funds that include liquid, regulated and transparent Irish-based UCITS funds.
“There has been a shift from a pure product and managed account-based offering, to a broader service offering where Lyxor’s managed account platform has become a centre point of expertise, providing clients with research, selection, products and infrastructure services in order to help them with fund investments across different asset classes,” says Spada.
Fee structuring is a focal point with hedge fund managers who act as partners on the Lyxor managed account platform.
“When we launch a new fund on our platform, we seek to offer our investors a genuine hedge fund strategy, in a liquid and transparent format with the lowest possible fee structure. The fee structure of our UCITS funds on the Lyxor Alternative UCITS platform is significantly lower than that of corresponding offshore peers. Negotiating the best fee level for our investors is part of our job, and is something we do for UCITS and non-UCITS vehicles, for commingled or dedicated managed accounts,” explains Spada.
Tages Capital has sought to innovate its business model by tapping in to the alternative UCITS space. Last year, Tages began to launch UCITS absolute return single manager funds on the Tages International SICAV fund platform domiciled in Luxembourg. The latest fund to launch, in partnership with Atreaus Capital, LP, is Tages Atreaus Macro UCITS Fund.
The Fund offers investors access to Atreaus’ proven expertise in macro portfolio management within UCITS limits and guidelines. The Fund launched with a minimum of EUR25 million of institutional capital. It brings the total number of UCITS funds on the Tages SICAV to five, which include:
- Tages Fore UCITS Fund (Global credit long/short);
- Anavon Global Equity Long/Short UCITS Fund (Global equity long/short);
- Tages Cygnus Europa Event Driven UCITS Fund (European event driven);
- Tages Rotella UCITS Fund (Systematic CTA);
- Tages Atreaus Macro UCITS Fund (Global Macro).
Discussing why Tages set the platform up, Morse tells Hedgeweek that a meaningful proportion of its clients are European insurance companies who generally prefer to invest in liquid, European regulated structures.
“Where full transparency is provided within Solvency II compliance this has a significant advantage with respect to capital ratio charges relative to non-transparent funds. In addition, since the advent of AIFMD, it has become harder for most European investors to access offshore structures and our platform offers investors in hedge fund strategies the opportunity to access these in a liquid, regulated structure.
“Another reason for setting up the SICAV, which relates to our seeding heritage, is that we’ve been early stage investors in a number of UCITS funds on other platforms. We feel that we can get a better deal for our clients by operating our own platform. We continue to look for best-of-breed managers, typically with day one capital of upwards of EUR25 million,” explains Morse.
When UCITS platforms, be they bank-owned or independent, are building out their fund range, care has to be taken to select the right calibre of manager and also, critically, one whose strategy has the best chance of standing out in a crowded market.
The most popular UCITS strategy, by a country mile, is equity long/short. There are, it could be argued, still areas of the market that are under-represented; particularly with respect to global macro.
“Whilst equity long/short is the easiest strategy to implement in a UCITS format, the challenge for some other strategies (including for example, global macro), from our perspective, is trying to find managers whose strategies work in a UCITS environment,” comments Ben O’Bryan, Executive Director, Goldman Sachs. “That’s not easy. There is a definite appetite from investors to diversify their holdings.”
Last year, there was a clamour for global macro funds. The difficulty with these funds, though, is the requirement to disclose leverage numbers in the UCITS KIID. Often, global macro funds end up using enormous amounts of leverage, which makes the regulators nervous; the last thing they want is a major blow-up that could jeopardise the UCITS brand.
“Macro can be hard because of the levels of gross leverage often employed,” continues O’Bryan. “There are a handful of Credit long/short funds in the UCITS space; I would say that both areas are under-represented at present. There are a lot of equity long/short funds these days, as well as CTAs. I do think the macro space is one that investors want to see (develop further) and we expect to see some launches soon.”
In Reutter’s view, choice is always good for investors. He argues that the best funds always stand out, ultimately, regardless of the strategy.
“There is more choice in equity long/short than other strategies but it is a popular strategy with investors because it is easily replicated in a UCITS structure and easy to understand. Some of the more complex, niche strategies have a more specialist investor target base. It’s not surprising to me that equity long/short is the largest sub-strategy by number of funds.
“There’s more supply in equity long/short but that doesn’t necessarily mean there’s more demand. When you look at AUM, for example, macro and multi-strategy are much bigger,” states Reutter.
With so much investor demand for UCITS products, some hedge fund managers can be forgiven for getting carried away and ploughing into this highly regulated space without due thought and consideration.
Attracting institutional dollars is top of mind, alongside performance, for any ambitious manager. There are, however, no guarantees that having a UCITS fund will act like a magnet to investors. Platforms are extremely diligent as to who they partner with. There has to be high conviction that any new fund brought to market succeeds in growing AUM as quickly as possible; the Two Sigma fund referred to earlier by Dreaneen is a good example.
“As a platform provider we have a responsibility not to shoehorn strategies into UCITS,” comments Laura Elliot, Vice President at Goldman Sachs, overseeing manager selection on the UCITS platform.
“As much as investors are looking for innovative strategies, we won’t put them on the platform if they don’t fit in the UCITS framework. For example, you have to be sure that the products you provide meet the liquidity and transparency constraints.”
Knowing what investors want is critical. Kenneth Sim, Head of Sales, ML Capital, which operates the MontLake UCITS platform, says: “We actively seek out managers to bridge the gap for investors. Even though we don’t ourselves seed, the network of seed investors we work with could decide to allocate to a new manager on MontLake if the solution we can provide them is correct.”
A UCITS fund that remains in the EUR20-30 million for too long is unlikely to succeed. When ML Capital actively selects a manager to go out and raise money for, the decision falls squarely on its shoulders.
“We make a qualitative choice based on research we would have done within our investor network to understand what they are looking for, to help us determine what the AUM growth potential of a new fund could be,” says Cyril Delamare, CEO of ML Capital. He offers the following advice to those thinking about launching UCITS:
“Understand the market and price your fund in a way that will appeal to investors. Be cognisant that in the early days there should be a seed price for the fund, then a growth price for the fund, and finally a maturity price for the fund. If you can figure out what those three pricing points are, then you will have a successful distribution strategy; provided your strategy performs.”
Elliot says that AUM growth tends to be exponential over time: “It can be a slow process, lots of small ticket allocations to begin with due in part to many investors holding ratio constraints and as the track record builds over time it starts to attract the attention of the larger investors who are likely to make larger ticket allocations.”
Another point to consider, at the pre-launch phase, is whether to launch a completely new product, making no reference to one’s existing offshore hedge fund, or whether to launch a UCITS that will closely – if not completely – mirror the offshore strategy.
“The best successes I’ve seen are where you have a high quality/brand name manager offering a UCITS fund pari passu to their offshore fund,” opines Dreaneen.
Ultimately, there is no point taking out 50 per cent of the book in order to fit it into a UCITS fund.
“Generally speaking, most successful UCITS launches incorporate all or substantially all of the flagship strategy; it can be a slower process to raise assets for a new or partially replicated strategy as investors will want to see a track record develop,” says O’Bryan.
There is an allure to having a UCITS fund. If the strategy can be properly managed within UCITS restrictions, and if it addresses a lacuna in the investor marketplace, managers can enjoy huge success, not just in Europe but globally (ex-US). Having a UCITS fund certainly adds an institutional seal of approval to one’s hedge fund business.
“We are definitely seeing more eagerness and interest from larger hedge fund managers (with respect to having a UCITS vehicle) than we were say four or five years ago. They understand the brand better; and they understand the calibre of investors. As the UCITS brand has strengthened, a lot of the larger managers are more willing to consider it.
“Having a turnkey solution that we can provide, where we do all the heavy lifting, is an attractive proposition to many managers,” says Elliot.
It is partly due to the support offered by platforms such as Goldman Sachs, Lyxor and ML Capital that US managers are showing greater willingness to move into this regulated area of the market.
This is evident by the recent addition of Connecticut-based hedge fund manager, Conatus Capital Management, to the Schroder GAIA platform back in May this year. The Schroder GAIA Conatus Equity fund, an equity long/short strategy, launched on June 7th 2017, and is managed by David Stemerman, co-founder of Conatus. This is the first foray into UCITS since Conatus was established in 2008.
ML Capital’s Delamare is adamant that the US remains a huge potential market from which further UCITS funds could by launched by managers.
“That said, you have to educate US fund managers on how to manage UCITS funds and to understand the cultural differences, such as moving from quarterly or monthly liquidity to daily or weekly liquidity; that is quite a big hurdle to overcome still.
“Still, we are seeing more and more interest from US managers who see UCITS as a diversifier away from their existing client base. They might have already launched ’40 Act mutual funds and so have gotten used to managing more liquid portfolios, and are thinking of taking a second step by launching a UCITS vehicle.
“There is tremendous opportunity in the US and I think over the next few years we will see a segmentation of managers and strategies, with more boutique and specialist fund managers coming to market i.e. sector-specific managers,” comments Delamare.
Platforms are able to take a lot of the burden away, in terms of regulation and compliance, or at least help with the set-up (if a manager wants a standalone fund). For that reason, Reutter believes it is “not as daunting as perhaps it might appear at first glance if managers partner with the right people”.
“We’ve already seen a good number of US blue-chip names launch, as well as smaller boutique names, so there’s definitely a good track record of managers having success. But there have been failures as well. Maybe they didn’t give the UCITS fund the attention it needed, maybe the manager was unlucky in terms of market conditions. I anticipate that US managers who want to have a footprint in Europe, should and most likely will, consider launching a UCITS. But it doesn’t come without its risks,” warns Reutter.
Many US managers have jumped on the ’40 Act bandwagon and a lot of assets have been raised, but there’s a big difference between ’40 Act funds and UCITS funds; UCITS funds can charge a performance fee, which ’40 Act fund cannot. So from a profitability perspective, UCITS is significantly more attractive.
“I think the US equity/long short strategy, as a category, still has plenty more room for new funds. There’s always room for good quality US equity-focused products. One of the problems is there are many US equity long/short managers who are capacity constrained. They have significant assets from large US institutions, which creates a bit of a conundrum,” observes Morse.
He says that in 2018, Tages Capital hopes to launch at least three more UCITS funds on its platform.
“We are and will continue to be opportunist. If we find interesting fund strategies that we think make sense for our clients we will seek to add them to the platform to widen the choice for our investors,” concludes Morse.
