Growth of UCITS III hedge funds: Global opportunities for alternative investors and fund managers

January 7th, 2010
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Contributed by: Lawrie Chandler, Alternative Decisions
The Growth of UCITS III hedge funds and global opportunities for alternative investors and fund managers More and more managers are using Europe’s UCITS III structure to create hedge fund-lite vehicles. With more regulators accepting the UCITS brand its importance to fund promoters is clear. There are important challenges in manufacturing and distributing UCITS funds so as long as managers have a clear focus and suitable operations the door is wide open to attract investors. UCITS III could be the road to recovery for alternative fund managers burnt by the financial crisis but the road is covered with potholes and road signs that must be adhered to.

Fund managers and promoters are attracted by UCITS III gold standard status and flexibility to accommodate the more liquid hedge fund strategies. There has been massive activity around UCITS III in the EU but also beyond Europe’s borders, in recent years non-EU sales of UCITS has accounted for 40% of total sales and Asian and Latin American sales have grown fast than the EU.
The challenge for building a fund in UCITS III remains education of investors, expectation management, marketing and distribution. Many of the hurdles created by the issues of 08/09 for offshore funds are solved with UCITS III.

UCITS to growth to be a global brand The UCITS brand has approximately EUR6.8 trillion under management according to the European Fund and Asset Management Association (EFAMA) at the end of September 2009. UCITS was developed in Europe to harmonise domestic EU markets for collective investment schemes.
The financial crisis demonstrated how intertwined financial markets had become built upon excessive borrowing. The shortcomings of opaque structures contributed to investors feeling they had been misinformed. The buzzword at the start of 2009 was transparency.

When confidence was shaken to its core investors looked at hedge funds and were dissatisfied. The crisis showed inherent weaknesses in hedge fund structures, strategies and operations. In addition, failures from disastrous risk management, poor due diligence processes and counterparty risks caused more damage. Finally investors lost faith when they were hit by side pockets, lock-ins and gates, haemorrhaging things further. The hedge fund world was left in pieces. An alternative structure was needed for hedge fund managers and UCITS has risen as that option.

Conveniently UCITS had been popular in the long-only space and had built a positive reputation. An EU Directive in 2001, creating UCITS III, allowed fund managers to partially deploy alternative fund strategies within the UCITS III space. The greatest development was the permission to use derivatives for investment purposes, as opposed to just hedging, making a range of hedge fund-type strategies possible within the UCITS framework. With little confidence in private placement regimes, fund managers have turned to UCITS as a flexible investment product, affording significant protection to a broad range of investors, while permitting sufficient investment latitude to allow managers to pursue their alternative investment strategies.

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