AUGUST 2007 COVER STORY UCITS3: Two way traffic

Ucits 3 has given traditional managers the opportunity to launch alternative funds. But, as Nick Fitzpatrick finds, alternative managers are using the rules to launch mainstream businesses that compete for the same client base

MPC Investors, a hedge fund firm with $1.4bn (e1.02bn) under management, gained over $500m (e364m) of assets in the first six months of the year after launching two Ucits 3 vehicles in January. One of these is the MPC Strategic Reserve Fund, which uses the full flexibility of Ucits 3 rules to employ derivatives.

The success in asset gathering at MPC mirrors a huge jump in derivative-based fund sales in the first five months of this year. But it also suggests that traditional long-only managers that have recently launched a small fleet of high-alpha funds under the Ucits 3 banner – such as the ubiquitous 130/30 – will have a tough fight on their hands to keep their old client base from straying to ‘alternative’ managers with similar products.

So far, MPC Investors, which was launched in 2000 and also runs ‘traditional’ strategies, has collected assets in its Ucits 3 range from the firm’s usual client base – high-net-worth investors, private client managers and funds of funds.

“But we do not see any reason why these funds should not be employed in the near future by pension funds and self-invested personal pensions,” says Dan Mannix, head of sales at the firm.

Tough competition
When long-only investment managers in Europe were granted powers to employ non-traditional strategies under the Ucits 3 regulations in 2001, it was seen as a welcome opportunity to defend their territory against hedge funds through the use of  high-alpha products which could be sold to clients who had become disenchanted with standard active long-only returns and fees.

After developing these products and running paper portfolios, these products are now starting to hit the market almost weekly.

But MPC Investor’s experience suggests that traditional long-only asset managers now face even tougher competition from hedge funds because they too are making use of the same Ucits powers to launch similar products into the same market as traditional long-only firms. These include long-only products, which MPC also manages.

RAB Capital, a London-based investment firm which specialises in absolute return funds, runs an Irish-domiciled OEIC fund, which has the ability to go long and short under Ucits 3. With just £55m (e82m) of assets under management in the fund, the firm expects this to grow because it recently received an award from Lipper, a ratings agency, and achieved a three-year track record.

Dexion Capital has four Ucits 3 closed-ended funds listed on the London Stock Exchange that provide access to a range of hedge fund managers and the firm counts pension funds among its investors. 

Just as Ucits has delivered the prize of shorting – or virtual shorting, which is enacted through derivatives rather than physical stock lending – to traditional managers, it has also delivered to hedge funds the coveted ability to launch products with a European regulatory seal of approval which is exportable globally. The largely unregulated and offshore nature of hedge funds has so far been seen as a barrier to deep penetration in the institutional and retail markets – at least at the level of smaller fund buyers.

Says Mannix, at MPC Investors: “We started the year with no regulated funds. But our regulated funds have gone from nothing to half a billion in no time!”

Amid the debate about whether long-only managers have adequate front office skills and back and middle office platforms to support and excel at alternative investing, hedge funds that originate Ucits products stand to be received well by distributors.

Margaret Dobak, head of product strategy and execution, Europe, at Citi Private Bank, tells Funds Europe: “Hedge fund houses already have the skills, know-how, systems and processes to deliver an interesting value proposition with alpha-enhancing hedge fund techniques without being categorised as a hedge fund. From a distribution perspective that is a powerful proposition.”

Enter the investment banks
MPC Investor’s Mannix claims: “Our client base likes these funds because they see a plethora of total return funds run by large traditional asset managers that have underperformed.”

Competition in the Ucits 3 environment is increased by the entry of investment banks, such as Nomura, which has raised $300m (e219m) in the past six months.

Garry Topp, director of sales, Nomura, says: “Ucits 3 has opened up a new vista. Some investment banks, like Nomura, have used the derivative strategies allowed under Ucits 3 to enter more deeply into the asset management market by bringing their particular expertise to the sector.

“Other banks see this area as an opportunity to compete directly with traditional asset managers in the battle for assets. For example, some of the US banks have developed whole ranges of derivative focused structured funds. This could be the start of a massive transformation in asset management.”

Topp says that Nomura started running Ucits 3 funds in earnest towards the end of 2006. Its Global Emerging Market 80% Protected Portfolio Fund was launched in February.

Nomura also has the S&P Diversified Trends Indicator Fund and the S&P Diversified Trends Indicator 80% Protected Fund, which were launched in October of last year. These Ucits 3 funds provide “unique access”, says Topp, to both the commodities and financial futures markets and have share classes tailored for retail and institutional investors alike.

Sub-advisory opportunities
In total the bank has five Ucits 3 funds on its Altrus platform covering emerging markets, Japan, property, commodities and financials. They are   passported on a pan-European basis and are licensed in Norway, Sweden, Spain and Italy, where they are distributed through banks, insurers and platforms.

But just as the investment banks represent more competition for traditional managers, they also provide opportunities for sub-advisory work. The asset management of the Nomura funds includes six third parties, such as Franklin Templeton, West LB, Pioneer and Pictet.

However, Topp adds: “Many of the skills in derivatives are with the investment banks. They are in a position potentially to compete more actively with asset managers in the field of structured funds as a result.”

Another recent Ucits 3 alternative fund to be launched by an alternative manager was in June when Halbis, the hedge fund arm of HSBC Investments, launched the Halbis Global Macro Fund. This was its first fund to use hedge fund techniques under Ucits 3. Adam Fairhead, global head of product development at HSBC Investments, said the fund is a Luxembourg Sicav and uses mainly on-exchange derivatives to take both forecast-free and forecast-driven bets on global markets.

The success of asset gathering at Nomura and MPC, along with the sudden spurt of product entering the market in recent months, takes place against a backdrop of a leap in derivative retail sales across Europe. According to figures from Feri FMI, a market data firm, in the first five months of 2007 funds containing derivatives represented 74% of total European sales. In 2002 these products represented just 17% for the whole year.

Dobak, at Citi Private Bank, says: “From a distribution perspective it is interesting to see how Ucits 3 is shaping up, but they are definitely taking off. Especially the 130/30 funds.

Across-the-board demand
“The demand is all across the board: from retail investors to ultra high-net-worth individuals. At the moment clients are looking mainly for broad large-cap mandates concentrating on the more developed and liquid markets like the US, UK and Europe.

“Clients will ask any distributor, who engages in open architecture, about Ucits 3 fund ranges.” She adds: “It is interesting to see what hedge fund houses are going to make of this opportunity, as they already have extensive experience in managing short positions.”

Topp, at Nomura, says: “It is a challenge for some asset managers to run the middle office and back office systems required for funds like these. However, these are skills that exist on the investment bank side.”

But distributors such as Citi can also help fund houses with the operational aspects of running high-alpha Ucits funds, says Dobak.

“One reason why traditional fund houses do not capitalise on the full Ucits 3 powers at the moment is because they might be lacking the right investment skills,  adequate risk management processes or administration to support derivatives and short selling strategies,” she says.

Dobak adds: “Citi has a robust funds administration platform. Fund  houses that run hedge funds can access the Ucits 3 space by going to back office providers like us. From a distribution perspective, one can envisage that if a distributor identifies a set of requirements from a client and sees that a particular manager has this capability, the distributor can link the manager to its own platform and provide the client with the product.”

Incentive for hedge funds
Part of the rationale for a long-only manager to launch a hedge-like fund is obvious. “Because market beta is getting easier to obtain – for example, through ETFs – 130/30 could theoretically help traditional managers keep clients and charge higher fees,” says Topp.

But why would a hedge fund create a watered-down version of itself for the pension scheme and retail market, or even create a long-only product?

Willie Watt, CEO at Scotland’s Martin Currie, an international long-short manager, has an answer. “Hedge funds are launching long-only products because they like the cycle for these kind of funds. In other words, they realise that long-only managers in the institutional space get fired less, and so the assets are more sticky. The turnover of hedge fund strategies can be much more frequent.”

The issue of fees
So hedge funds hope that fees will become more sustainable in the Ucits environment, while traditional managers hope to increase their fees to hedge fund-like levels. The issue of fees is the next major test for recent launches. After all, Ucits 3 funds that take advantage of all the clever investment options are still not bona fide hedge funds.

Matt Hollier, head of corporate development at Old Mutual Asset Managers, says: “The [Ucits] rules require [long and short positions] to be achieved using derivatives, not outright short sales, and leverage limits apply, but this allows the central element of hedge fund strategies to be pursued.”

David Zobel, head of hedge fund strategies at BlueBay Asset Management, says: “Ucits 3 and standard hedge funds are inherently different.

“The Ucits 3 product, such as 130/30, is very interesting, but at the end of the day, the investor still has market exposure. If they want to avoid correlation with the market then they will need to consider a standard hedge fund. Ucits 3 simply provides the manager with more flexibility to add alpha.”

Dobak, at Citi, says that fees is an important area. “Traditional managers with Ucits 3 hedge funds need to be realistic about their fees. Only the top hedge funds can really call for top fees. We think fee structures along the lines of hedge funds will be accepted, meaning a traditional basis point fee with a performance fee on top.”

MPC Investors’ Strategic Reserve Fund, which is a total return fund, charges 135 bps management fee plus 10% of outperformance over a cash return, while, for example, Investec’s recent Global Extension fund, which is a 130/30-style fund, charges institutions 65 bps with 20% outperformance.

Citi’s Dobak says: “I would be concerned if Ucits 3 fees went to the level of hedge funds because Ucits 3 funds do have certain constraints that pure hedge funds do not have. A 20% performance fee, for example, I think will need to be tested by the market.”

© fe August 2007



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