June 2012

FUND LAUNCHES: It’s a case of expensive tastes

Credit-cardData on recently launched Ucits hedge funds shows performance fees are alive and well. George Mitton reports.

There were 181 alternative and absolute return Ucits products launched since 1 January, 2011, according to Lipper (data collected on May 2). This dataset captures most, if not all, the funds loosely termed Ucits hedge funds – products that can invest in a wide range of assets and employ techniques such as short selling or leverage to increase returns.

The idea of selling this kind of fund within a Ucits wrapper is to give investors peace of mind. Investors get the potential high returns of a hedge fund, but also the security of knowing their fund is regulated by the most common and familiar regime in the business.

However, Ucits guidelines imply restrictions that offshore, lightly regulated hedge funds would not have. Does this mean investors should expect less inspiring returns with a Ucits hedge fund than with a Cayman Islands one? It depends who you ask. Some say the Ucits framework actually helps managers make wise decisions.

But what does seem clear is that having a Ucits wrapper on a hedge fund need not affect the fees the fund charges, particularly performance fees. A survey of the data suggests fees for many Ucits hedge funds are high, and that the performance fee is alive and well.

We took the ten funds from Lipper’s dataset that had the highest annual management charges. Among them, the charges ranged between 2% and 3%. Additional research by Funds Europe found that each of the ten also has a performance fee of some kind.

Performance fees
The performance fees are expressed in different ways, although the proportion of 20% features in all but one. A typical wording would define the fee as 20% of net new profit above a “high water mark”. In some cases, the fee is levied on outperformance of a benchmark, such as Libor.

There was one fund of the ten that had a different method, the BG Selection Anima-Club fund, from Generali Fund Management: it charges 0.007% of the fund’s net asset value for each percentage variation of return obtained by the fund.

For some funds, performance fees vary depending on share classes. Institutional investors might be charged different performance fees to retail clients, for instance. Funds Europe has generally chosen data relating to retail share classes that are denominated in euros.

Performance fees have been criticised in the past on grounds that they give hedge fund managers an incentive to take excessive risks. If the risks pay off and the fund performs well, the managers earn large sums from performance fees. But if the fund loses money, this loss is borne by the investors only.

To put it another way, there is no “underperformance rebate”; fund managers do not compensate investors for losses if the fund underperforms.

However, defenders of performance fees insist that these structures are a good way of aligning managers’ interests with those of their investors. And the prevalence of performance fees among these high-cost Ucits hedge funds shows the practice is ongoing.

But what about performance, are high fees an indicator of good fund performance? Funds Europe’s investigation is not extensive enough to draw firm conclusions, but a look at the funds in the top ten yields some interesting results.

The most expensive fund, the Swiss Peaks Saentis fund from Assenagon Asset Management, which launched in November last year, is down 9.6% since the start of the year (Bloomberg data, as of May). The Quant Global Equities Fund, from Lux Financial Group, is down 32% in the last twelve months.

Given that hedge funds of all kinds have struggled with lacklustre returns in the past year, it is likely that few performance fees have been paid out recently. But should the markets pick up, and should hedge fund managers have more luck with their trading strategies, the question of performance fees could become pressingly relevant – for both offshore and Ucits hedge funds.

©2012 funds europe