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Comment by Joy Dunbar, Editor of Absolute UCITS
Complex and risky are really not the same thing – though, unfortunately, in the world of investments they are commonly confused or used interchangeably. This is more poignant than ever as the discussions about whether alternative UCITS funds should be classed as ‘complex’ investments is being reviewed by legislators in Europe.
There is no definition of what a complex UCITS fund is. But if a fund is classed as complex this means that it is not allowed to be bought on an execution-only basis. Currently, all UCITS funds are regarded as non-complex. But I suspect that the complex definition will include some or all of the following financial instruments – derivatives, synthetic shorting (UCITS funds can’t short directly) and use of indices.
The first version of the UCITS Directive, which came into force in 1984, wrapped up plain vanilla investment vehicles – equities, bonds and financial derivatives instruments that could be used for efficient portfolio management. The informal split came about in the earlier part of the last decade as a result of UCITS III being enforced, and now other financial instruments like derivatives and indices are able to be wrapped up within the UCITS Directive. However, the European Securities and Markets Authority is currently consulting on whether it should make the so-called divide between ‘alternative’ UCITS and ‘plain vanilla’ UCITS formal because of increasing concerns about the retailisation of the hedge fund strategies.
But are alternative UCITS funds riskier because they are defined as complex? The answer should be no – as there is no direct correlation between riskiness and complexity. All investments come with risks and it is a matter of fact that many non-complex funds have lost their investors a lot of money.
Also, regulation does not guarantee that a fund will perform or that it will prevent a blow-up. That is not the job of regulation.
That said,, whenever an investor invests in a particular financial instrument they need to understand what they are investing in, how it could be impacted by a major liquidity event and how it achieves (if there is any) alpha. And there is the case for educating retail investors – just as there is an argument for separating retail and institutional investors because they have different investment horizons, behaviour and objectives.
The financial services industry, for asset managers and investors, has changed dramatically since 1980s and the first UCITS Directive. The Directive has to move with the times and ensure that it is fit for purpose regulation.