By Neil Wilson
In Europe debate continues to rage about the European Union's proposed Alternative Investment Fund Managers (AIFM) directive. U.S. Treasury Secretary Tim Geithner was among the latest to raise concerns about its potentially protectionist effects with EU Commissioner Michel Barnier. Hopefully, the most harmful provisions can be headed off before the directive is finalized, but the eventual outcome is still very much in play.
Meanwhile, another EU directive—the one governing so-called Undertakings for Collective Investment in Transferable Securities (UCITS for short)—seems to be having a strangely opposite effect, galvanizing the industry.
The latest version of this directive, usually referred to as UCITS III, came into force several years ago. But it is only in the last year or two—since the recent financial crisis—that the asset management world seems to have grasped that this previously unglamorous onshore structure allows significant flexibility for onshore funds in Europe to adopt some genuine hedge fund strategies and techniques. UCITS funds, for instance, can hedge up to 100% of their portfolios—which means they can in effect go as much short as long, at least synthetically, and even run market-neutral strategies with gross exposures of up to 200% (potentially more on some interpretations of the rules).
Some big European hedge fund groups, such as Marshall Wace, were early adopters of UCITS III fund structures. And from the other side of the fence, among the big mainstream firms offering traditional long-only mutual funds, there has also been a growing realization that they could offer something much closer to and more competitive with hedge funds—genuine absolute return funds—within a UCITS format. Firms that are big in both long-only and hedge funds, such as BlackRock, were among the quickest off the mark. The BlackRock UK Absolute Alpha Fund, launched in April 2005 and managed by Mark Lyttleton, was one of the first of these absolute return vehicles. Using its ability to hedge, it came through the financial crisis of 2008 better than most equity hedge funds and has recently grown close to $3 billion in assets.
What was initially a trickle of UCITS funds has turned into something that increasingly resembles a flood. According to EuroHedge, only 142 new European hedge funds were launched in 2009, the lowest number since 2000. And the assets they raised, at just over $11.1 billion, were the lowest since 2002. On the other hand, a further 65 hedge fund strategies were launched in a UCITS format during 2009, raising an additional $5.7 billion. Only 41 of those were genuinely new funds, and 24 of them were "clones"—new versions of existing hedge funds in a UCITS format—but with assets raised of $3.4 billion and $2.3 billion, respectively, they could hardly be called inconsequential.
Overall, despite a 10% rebound from the midyear low, European hedge fund industry assets still shrank a little from $398 billion in January 2009 to end the year at around $382 billion. However, if one adds the $22.7 billion now running in European hedge funds with UCITS III structures, that makes a grand total of nearly $405 billion, back above where it was a year ago.
Because various funds counted the previous year, such as the whole $4 billion stable of long-short funds managed by Exane Asset Management in Paris, have now been converted to the UCITS format, many argue that the higher figure is the fairer comparison.
Total hedge fund assets in a UCITS format is still pretty small beer compared to the immense $5 trillion in long-only UCITS funds. But there is right now something approaching a stampede from both hedge fund and long-only firms to set up more hedge funds in a UCITS format. And the HedgeFund Intelligence data team, via a new UCITS database, aims to keep close tabs on how this grows.
Nevertheless, we remain conscious, as do many in the industry, that it would be highly premature to get carried away with the notion that European hedge funds will suddenly convert en masse into a UCITS format. For one thing, the current rules for UCITS require funds to be very liquid—investors are entitled to redeem at 14 days' notice—which is one of the key attractions for many investors but doesn't suit a lot of strategies, many of which require more leverage than 200%.
And while it may be good to have more hedge funds onshore, plenty of investors may still prefer to remain offshore.