Fitch Ratings said in a recent report that uncertain market liquidity or the inability to fully deploy leverage may make some credit hedge fund-like strategies less than compatible with a UCITS structure. The agency says many credit hedge fund strategies are now largely available in a UCITS format (commonly referred to as NewCits).
Fitch estimates that the total assets under management (AuM) of European credit UCITS funds, which have an absolute return objective and employ hedge fund strategies, is approximately EUR20bn.
The attractiveness of promised de-correlated credit returns and the safety of a regulated format have driven the growth of the sector. However, liquidity and leverage are the main factors limiting the wider use of hedge fund strategies under UCITS. For this reason, the credit long/short strategy is the most commonly used strategy in UCITS-compliant credit hedge funds.
Despite the recent market turmoil, top quartile Credit Newcits funds managed to deliver positive year-to-date returns as of end of August. Less than 6% have achieved returns above 5%. Funds that were long volatility and neutral credit spreads outperformed their peers.
"Hedge fund-like strategies have enabled around a quarter of credit UCITS funds to achieve positive, uncorrelated credit returns in August," says Manuel Arrive (pictured), Senior Director in Fitch’s Fund and Asset Manager Rating team. "However, certain credit hedge fund strategies may not be well-suited for the UCITS rules as the strategy may not be liquid enough to be successfully executed in all stressed conditions. Therefore, investors need to be mindful of style drift, as the return potential of liquid relative value strategies diminishes"