UCITS Alternative Strategies
Up until about 3 years ago most alternative investment strategies were not available in a UCITS*-compatible format. In fact, the vast majority of hedge funds were domiliced on the Cayman Islands. Whilst early attempts at creating UCITS-compatible hedge funds date back as early as 2002 when the UCITS III** directive became effective, the majoirty of so-called "Newcits" stormed onto the scene post the Financial Crisis in the wake of the Madoff scandal. Most of these funds are spin-offs of EU-unregulated Cayman-domiciled funds.
*Undertakings for Collective Investment in Transferable Securities
**since June 2011 UCITS IV, which has simplified Pan-European passporting/distribution
Most investors are familiar with the specific benefits a UCITS wrapper offers, but here is a brief overview:
- Highest level of regulation for any European collective investment product - in relation to custodial, administration and auditing arrangements; in terms of restrictions on investments and investor protection
- UCITS funds have daily or weekly liquidity – a key requirement for many investors
- UCITS, especially UCITS IV, provide a European passport to market funds on a Retail and Institutional basis to virtually every fund buyer
- UCITS are currently also the “wrapper brand of choice” for Asian and Latin American markets
Whilst "Newcits" (UCITS hedge funds) are better regulated, they tend to underperform their unregulated peers due to various investment and risk limitations, set out by the UCITS regulations for leveraged transferable securities; but what are the specific causes for this underperformance?
The main reason lies in the fact that whilst under the "Transferable Securities" route of the UCITS directive a number of hedge fund strategies (such as long short equity, long short credit, Convertible Arbitrage, Global Macro, Event Driven, CTAs and Managed Futures) are allowed; this is allowed only via synthetic (i.e. derivatives) and not physical exposure. In addition to that there a number of specific restrictions, the most prominent being that of a 200% gross exposure limit. This means that particular strategies which were previously executed via a Cayman-domiciled fund have moved from physical to synthetic shorting and had to limit their gross exposure which previously may have been unlimited.
A small number of UCITS hedge funds use another mechanism in order to be UCITS compliant - that of investing into (proprietary) hedge fund indices whose composites are managed account returns. The UCITS cash accounts the investors have allocated to benefit from the (tradtional, unrestricted) hedge strategies via a total return swap.
PDL International has partnered up with the pioneer of this approach Salus Alpha. Please read more here.