August 5, 2010 6:56 pm

US hedge funds embrace the benefits of Ucits

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On a Monaco rooftop in June, the sun glittering over the Mediterranean as it dipped below the Cap d’Ail, about 200 hedge fund managers, many from the US, glugged champagne after a day discussing something rather less bubbly: “undertakings for collective investments in transferable securities”.

Ucits, though, are the biggest thing in the hedge fund industry. Ostensibly a variety of European mutual fund, tightly regulated by EU laws, they have become the toast of London’s Mayfair and now New York.

Thanks to tweaks in the EU laws that created Ucits, hedge fund managers have discovered ways to repackage their strategies in Ucits form. In doing so, they have accessed retail and institutional investors who had been shut out of the high-octane hedge fund world.

“Ucits hedge funds now account for 7 per cent of the total hedge fund universe of $1,500bn but have attracted 20 per cent of the net inflows into the industry year-to-date,” according to Alexander Mearns, chief executive of Eurekahedge.

Hitherto, almost all Ucits start-ups have been European. But, as the accents in Monaco at the GAIM hedge fund conference this June attested, there are signs that is changing.

The attraction for US managers – as for European – is twofold. First, Ucits funds are to be exempt from the forthcoming AIFM directive, an EU law that threatens to freeze US managers out of Europe. Second, Ucits are a way for hedge funds to tap a vast institutional investor base.

According to consultancy Eurekahedge, there are nearly $100bn of Ucits-compliant hedge fund investments in about 980 funds open to retail investors, a number that has leapt in the past 18 months from almost nothing.

“There are a lot of European countries where it is very difficult for investors to put money into offshore hedge funds,” according to Emmanuel Roman, co-chief executive of GLG Partners. “The bylaws of lots of companies in Germany and France prevent it.” Ucits are familiar and saleable.

As yet, York Capital Management, the $13bn US event-arbitrageur founded by James Dinan, is the only US hedge fund to have a Ucits fund up and running, but not for long.

Paulson & Co – the $31bn hedge fund manager that shot to prominence in 2007 thanks to its successful bets against the US subprime market – was revealed last week to be planning a Ucits launch. Traxis Partners, the hedge fund of legendary investor Barton Biggs, also has a Ucits fund in the pipeline.

Both will be pipped to the post by another US hedge fund manager. Peter Schoenfeld Asset Management, one of the US’ best-regarded merger arbitrageur specialists, is to launch a Ucits fund imminently, people familiar with the situation said. Marketers expect to raise between $300m and $500m for the fund.

For US managers looking to launch Ucits funds, there is an added wrinkle: EU law requires Ucits fund managers to be domiciled in the EU. Bank platforms, which involve co-branding, are the only way US managers can create Ucits funds.

Bank of America Merrill Lynch, Deutsche Bank and Morgan Stanley are among the most prominent Ucits-platform operators pushing their expertise stateside. One executive at a large London hedge fund manager said: “They’re looking at the top 50 funds in the US to do it with. There’ll be a lot more US manager Ucits fund launches.”

But there are problems. Ucits have to be highly liquid and transparent. They have investment limits. Mr Roman says: “There are some products for which it works and some for which it doesn’t: distressed, fixed income arbitrage, for example. The way I think about it is to imagine how the fund would fare if all the money had to come out in two weeks.”

Paul Graham at UK fund manager Gartmore agrees. “What we do on the equity long/short hedge fund sides is extremely portable into the Ucits framework.”

There is an added danger in trying to attract institutional investors into what was designed as a retail product, Mr Graham says. “They are not aligned with Mr Smith and Mrs Jones in Manchester or Cardiff, who have very different objectives to institutional investors. When they redeem their much larger investments, they can move prices.” Were that to happen, small investors could get crushed.

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