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Investors should perform greater operational due diligence on Ucits hedge funds, states industry expert

Thursday, June 23, 2011

David Miller
Opalesque Industry Update - Reporting from the GAIM conference in Monaco, the peer group network COO Connect noted that hedge fund industry expert, David Miller, a partner at the £3.6bn ($585 bn) investment management house Cheviot Asset Management, believes that investors should perform greater operational due diligence on Ucits hedge funds. Miller urges that investors should not assume that onshore regulated products are safer than their offshore versions.

Miller pointed out that while Ucits vehicles have many positives including better transparency, generous liquidity and a more favourable tax treatment for UK investors, this should not be an excuse for complacency among investors.

“Investors need to understand the strategies to ensure what they buy into is what they get. Just because a fund is Ucits rather than Cayman does not make it safer in any way. This situation is similar to when investors bought into listed hedge funds prior to 2008. Many investors believed these funds offered low volatility and absolute returns. Many unfortunately turned out to be highly correlated much to the disadvantage of investors during the crisis,” he said.

COO Connect reports: “While urging greater investor operational due diligence on Ucits, Miller simultaneously stated Ucits hedge funds needed to become more focused on seeking absolute returns for their clients. He stressed that Ucits hedge fund managers must be more ambitious and should focus on real returns after inflation for some of their less risk-averse clients – particularly the ever growing number of funds of hedge funds who are allocating into the Ucits space post-crisis. This is important given that many Ucits funds are suffering a decline in the real value of their wealth. Furthermore, Ucits vehicles often face higher prime brokerage fees and marketing costs than unregulated entities which inevitably eats into their profit margins.”

“Ucits hedge funds do have a lot of advantages but managers do need to think more about the total expense ratio. The prime brokerage and marketing costs of these funds is higher than those of offshore hedge funds. Given that Ucits are not making as much money at the moment, these costs are going to eat into the fund’s profits. To solve this predicament, I think Ucits hedge fund managers need to seek more ambitious returns and diversification with different rules for different clients. Balance is important,” Miller acknowledged.

However, there is growing concern in some quarters about fund managers shoehorning illiquid strategies into Ucits hedge funds. There have been warnings that such behaviour could facilitate a liquidity crisis in Ucits resulting in widespread investor resentment and mistrust. This is something Miller believes is a distinct possibility. “If there is a crisis situation and everyone is trying to get out of the market, there could be a liquidity problem among Ucits,” he highlighted.

Ucits have enjoyed a major investor uptake following the aftermath of the financial crisis. In February 2011, a Deutsche Bank survey of sophisticated investors revealed inflows into Ucits III absolute return vehicles could significantly outstrip allocations into Cayman funds. These investors, albeit overwhelmingly European, said they would allocate more than $185 billion into Ucits III hedge funds over the next 12 months. In 2010, Cayman-domiciled funds experienced $55 billion in capital inflows.

The Deutsche Bank Hedge Fund Capital Group estimated there are $150 billion in assets under management in Ucits III absolute return funds. Furthermore, the February survey indicated this figure could more than double over the course of the year. It also revealed 72% of wealth management firms, 67% of family offices and 61% of private banks preferred Ucits structures to the traditional offshore model.

Beverly Chandler

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