The Rise of Alternative UCITS
Alternative UCITS, the European equivalent to the US 40 Act liquid alternative funds, have seen significant growth from 2008 onwards. This growth has been driven by investors looking for risk adjusted returns in a liquid, regulated product while favouring the established UCITS brand. Assets in Alternative UCITS grew by more than 30% a year from 2008 onwards and the exceptional growth of recent years is continuing, with assets growing by a further 34% in the year to March 20151.
For investors, the benefits include gaining access to hedge fund returns via a highly regulated product. Risk-driven rules around leverage, concentration and counterparty risk are part of the framework and differentiate UCITS from typical offshore hedge fund products or AIFMD funds, the European regulatory framework for hedge funds. There are liquidity benefits in that investor dealing at a minimum of a fortnightly basis is required and many funds in practice offer daily or weekly liquidity.
For hedge fund managers looking to build assets in Europe, Asia and Latin America, UCITS presents a compelling option. However, a manager will need to carefully consider whether their chosen strategy can deliver an attractive return while adhering to the additional requirements of a UCITS product. The rules on eligible assets, asset concentration, liquidity and leverage mean the framework is not suitable for every hedge fund strategy. Equally what is clear is that a range of strategies do fit. Equity and macro strategies dominate the list of Alternative UCITS strategies in existence today, while credit, multi-strategy and relative value strategies also feature prominently.
There are operational considerations too. Physical short selling is not permitted but the investment rules do allow for access to short exposure through the use of eligible derivatives, typically via swaps or contracts for differences. While the traditional prime brokerage model is not an option, funds may employ a synthetic prime brokerage model to facilitate access to short selling and leverage. With all of this, it is key that managers ensure that they have an appropriate risk management plan in place to manage liquidity, leverage and counterparty risk within UCITS requirements.
For managers that do have a viable UCITS proposition, one of the key benefits is distribution. Europe is by far the largest market for UCITS sales and the vast majority of European countries have seen growth in the number of funds registered for sale in recent years. UCITS established in one EU member state are authorised for sale across other EU member states on a passporting basis.
As a globally recognised brand, UCITS funds are also sold widely in Asia and in Latin America. It is the most popular offshore fund brand in Asia and the three major cross border fund centres of Hong Kong, Singapore and Taiwan are the main centres for distribution in the region. Gaining access to these markets under the trusted UCITS banner is proving hugely attractive. The brand is also increasingly popular with Asian managers looking to secure European capital in Asia focused funds. UCITS are being utilised as a vehicle for providing investors with access to the Chinese market through the Renminbi Qualified Foreign Institutional Investor and Qualified Foreign Institutional Investor schemes. While Stock Connect is another exciting opportunity for investors to gain access to the Chinese mainland market via Hong Kong, there are threats in Asia too, including initiatives to launch a regional equivalent via the establishment of passporting schemes for Asian funds.
Even with the threats facing UCITS and the advent of AIFMD, which offers a fund structure for alternatives with similar distribution benefits in Europe, UCITS’ position as an established global funds brand means its success is likely to continue. As long as it does, and as alternative strategies continue to become more mainstream, then UCITS is likely to continue to see interest from investors looking for hedge fund returns in a regulated product.
Ireland is a leading centre for the establishment of UCITS. With an extensive distribution model that supports distribution of Irish UCITS funds to 70 countries globally today, Ireland has the infrastructure in place to act as a gateway to new markets for managers launching a UCITS product. Ireland's position as the leading centre for the servicing of alternative funds combines to offer an ideal blend of UCITS and hedge fund experience for the support of Alternative UCITS funds.
Cathal Cornally, Senior Manager, Accounting & Valuations
HSBC Securities Services (Ireland) Ltd
1 Sources: HFMweek UCITS Report 2015. PWC Alternative Asset Management 2020.