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Ucits hedge vehicles to flood sector

Date: Monday, January 11, 2010
Author: Steve Johnson, Financial Times

A wave of investment vehicles targeting the new breed of “onshore hedge funds” is set to be launched in 2010 – despite even their sponsors believing they will have lower returns and higher costs than funds already on the market.

Some 80 per cent of established fund of hedge fund providers intend to launch similar collective vehicles investing in a basket of Ucits-compliant hedge fund “lite” products in the next 12 months, according to a survey by London-based KdK Asset Management.

The move comes after a host of leading hedge fund houses, such as Man Group, Brevan Howard, GLG Partners and Marshall Wace, have created onshore, regulated Ucits funds, dubbed “Newcits”, in response to investor demands for greater protection and regulation.

However, more than 90 per cent of fund of funds believe these Newcits vehicles will have lower returns than their equivalent offshore versions, according to the KdK survey, with a quarter expecting the shortfall to be greater than 3 percentage points a year.

This shortfall is expected because Ucits hedge funds face restrictions on levels of leverage, are prohibited from making direct investments in commodities or physically shorting stock and must provide fortnightly liquidity, restricting their ability to invest in illiquid assets.

Further, almost 80 per cent of the respondents said the cost of investing in the underlying Ucits hedge funds – as expressed by the total expense ratio, the broadest measure of cost – was likely to be higher than that of investing in traditional offshore funds. These charges are passed on to fund of fund investors.

KdK said most of the Newcits launched to date had retained the “2 and 20” fee structure, comprising a 2 per cent annual fee and 20 per cent performance levy, commonplace in the offshore world, while administration and custody costs were likely to be higher for onshore funds.

“Most of [the respondents] consider that the performance of the Ucits hedge funds is likely to be lower than the offshore funds and that their TER is likely to be higher,” said Henrik de Koning, co-founder of KdK.

“They are probably going to be less attractive or have a worse risk/return ratio than a traditional fund of fund. But Ucits has lots of advantages in terms of distribution.”

The fund of funds industry believes the biggest selling points for these Ucits vehicles will be access to retail investors, who are generally wary of offshore funds; and better liquidity terms, which stop managers of the underlying funds from limiting redemptions by imposing suspensions, gates and sidepockets, a scourge that has afflicted the hedge fund industry in the past two years.

Managers also laud the improved regulatory oversight, transparency and risk management of the Ucits world.

Three-quarters of fund of fund houses said they had had demand from both retail networks and fund platforms or distributors for Ucits vehicles. Around two-thirds had demand from family offices and wealthy individuals and almost half from institutional investors and insurance companies.

HSBC, Collins Stewart Fund Management, Switzerland’s 3A, Permal Group, and Kairos Partners of Milan have launched funds of Newcits in recent months.

More than half of the houses surveyed by KdK said they intended to follow suit within six months, and a further quarter within a year.