An alternative road to European investing

When European Ucits funds were launched in 1989, a Price Waterhouse partner – as PwC was then known – told a probing US newspaper that it would take a big effort to capitalise on their opportunities.

But he immediately added that no one wanted “to be left at the dock when the boat pulls away”.

And boy, did the boat pull away. The undertakings for collective investment in transferable securities industry now weighs €5.8tn in terms of assets under management and has become a global brand with funds exported far beyond the European borders.

Fast forward to 2012 and Europe wonders whether it is about to repeat the same success story with the arrival of the alternative investment fund managers (AIFM) directive. However, this time it is hard to find anyone excited about the new regime.

Some continental managers believe AIFM will demystify hedge funds and make them more respectable, but many are still sceptical about the effect of the directive.

Bernard Madoff’s use of Ucits funds to channel European money into his Ponzi scheme showed the difficulty for a regulated fund framework to build its reputation around investor protection.

According to a recent Deloitte survey, a majority of asset managers view the directive as a business threat. Small firms are particularly concerned.

Albert Küller, investment consultant at Bluefin, says: “Certain managers might struggle, not having the in-house capacity to comply with the new directive. This could decrease the European variety of alternative investment managers.”

Although the purpose of AIFM is to closely supervise alternative managers in an effort to fight systemic risk, the directive will also allow alternative funds to be sold across Europe for the first time.

Michelle Carroll, a partner at international accountancy and business advisory firm BDO, says: “It will be frustrating for small asset managers to implement AIFM but if they want to make business in Europe, they’ll have to do it.”

Demand from institutional investors will be a key factor to consider for hedge funds. Will AIFM help grow European pension funds’ allocation to alternative investments?

Figures show that only 20 per cent of European pension funds hold an allocation to hedge funds, emerging markets debt or high yield. And allocation to individual alternative asset classes is often limited to 3-5 per cent, according to investment consultancy Mercer.

Michael McKee, a partner at law firm DLA Piper, says: “My own feeling is that there will be a greater likelihood an EU legislative framework will make investors more comfortable investing with hedge funds.”

Investors are often restricted in how much they can invest in non-regulated products, which provides an advantage to existing onshore products, such as the Irish qualifying investor fund. AIFM will build on that.

Fionán Breathnach, a partner at Mason Hayes & Curran, the Irish law firm, says: “AIFM will give European institutional investors more comfort in terms of fund regulation. The directive could also improve upon the advantages of existing onshore vehicles.”

Any growth is expected to take some time though, as pension schemes adapt to the new products and modify the parameters of their mandates in order to invest in alternative investment funds, adds Mr McKee.

Mr Küller says: “Institutional investors might favour the increased transparency, governance and the use of an independent valuer. Some larger pension schemes might make changes to the statements of investment principles.”

However, others doubt investor demand for hedge funds will increase because of AIFM.

“Those investors that do not currently invest [in hedge funds] are unlikely to be persuaded by the AIFM stamp of approval,” says Pete Drewienkiewicz, head of manager research at Redington, a consultancy.

“Most barriers to investment in alternatives are governance-driven rather than regulatory.”

Ms Caroll adds: “I don’t think AIFM will add a lot of value. The small managers will continue to be small, and those that wouldn’t do business with the Cayman Islands will continue to think the same.”

Investors will still be expected to do a lot of due diligence on hedge funds, including on their past performance, relations with regulators, reporting, risk controls and systems.

“Whether the AIFM existed or not, if you are a good manager you will have the right controls and you shouldn’t be told by the directive to have them in place,” says Ms Caroll.

“I don’t think all that AIFM requires will make good for due diligence. You probably want to do more of it.”

AIFM will not provide more cover than it actually offers, but it could still become a benchmark onshore vehicle for hedge funds. And demand would be likely to follow, as it did with Ucits.