Hedge fund experience counts when choosing a manager for a Ucits products, concludes a study by Lyxor Managed Account Platform (MAP) Research. Regulation, too, negatively impacts returns, says the study.

The performance of Ucits hedge funds is affected by two things: regulation and the skill set of the manager. “Regulation has an impact on returns,” says the latest analysis of the Ucits absolute return universe by Serge Darolles, Lyxor managed account platform (MAP) researcher and author of the study.* The performance of a hedge fund in a Ucits wrapper will often suffer because of this.

Interestingly, the report also discovered that managers who ran hedge funds did better running Ucits products than their long-only counterparts with no experience of hedge fund strategies.

“Hedge fund experience counts,” says the Lyxor report. “Ucits managers that leverage on hedge fund management expertise and infrastructure outperform their Newcits counterparts with a more traditional approach,” it concludes.

“Skilled fund managers are able to implement hedge fund-like strategies in a less flexible format to get better performance,” says the report. “Non-skilled managers are not able. These two results are in line with the ones obtained by Agarwal et al (2007) when studying their set of mutual hedge funds,” it adds.

Darolles believes unlike the 2010 report, the current one is able to give a more accurate picture of the Ucits hedge fund universe and differences between fund types, strategies and managers. On the technical side, Darolles says Lyxor is using a new database. “Our sample is 450 funds so we have multiplied by three the number of funds analysed. This is very important when looking at relationships. You need to have statistically significant numbers.”

Classifying managers
Another new feature is the classification of skilled and unskilled managers. Darolles says this is an important distinction investors should take into consideration when choosing a Ucits hedge fund.

The survey results show managers with hedge fund experience are able to operate in the Ucits framework with better risk-adjusted performance than their non-hedge fund experienced Ucits counterparts.

Results are especially significant for the global macro and relative value strategies. Experienced hedge fund managers generated a statistically significant incremental of 14 basis points (bp) and 9bp a month compared with their non-skilled Ucits counterparts. A similar result was observed for equity hedge Ucits products.

When hedge fund-experienced Ucits are isolated, they demonstrate a further decrease in volatility as compared with their non-hedge fund-experienced counterparts.

For example, traditional hedge funds in the equity hedge strategy have 3.09% higher annualised volatility than their Ucits counterparts. In the same strategy, hedge fund experienced Ucits managers offer a 0.83% reduction in volatility compared with non-hedge fund experienced counterparts. With the performance, however, there is considerable heterogeneity in specific results, depending on which strategy is considered, warns the report.

“Intelligent selection that can identify those Newcits that retain performance potential and fully comply with Ucits requirements, has the real potential to boost risk adjusted returns and in the context of a regulated, onshore investment,” says the report. “Optimal solutions may lie in a growing range of Newcits funds of funds, provided they are offered by established alternative asset managers with a proven fund management record.”

Closer exposure
For those investors who require the Ucits wrapper but want to retain an exposure closer to traditional hedge funds than a Ucits can offer, Ucits funds where the underlyings are hedge fund Ucits-compliant but not pure Ucits are a solution. Another option is Ucits-compliant funds invested in managed accounts directly or through indexes, advises the report.

Where the underlying managed account offers complete risk monitoring, funds offer a triple benefit: Ucits compliance, performance potential more aligned with the traditional hedge fund model and a robust risk-controlled framework, says the report.

Another result not previously detected in the 2010 report is the fact there is a cost for investing in a regulated Ucits. However, there are indications that hedge funds Ucits may compensate with reduced risk. The differences in performance vary meaningfully between strategies with global macro/CTA paying the higher performance premium.

The report shows that investors pay a premium for the safety associated with the more regulated vehicles. “This empirical analysis cannot be done without controlling the strategy structure. Indeed, the relative weights of each strategy can be different from one group to the others,” cautions the report.

It also found that regulation may have a different effect across strategies.

The impact of regulation
Ucits regulation has a performance impact as mean annual performance is significantly lower for hedge fund Ucits (3.30% compared with 7.62%). At the same time hedge fund experienced managers bring incremental value in the Ucits context as mean annual performance is lower for managers without experience (2.80% compared with 3.80%).

Mean annual performances are lower for all hedge fund Ucits strategies: 4.78% compared 7.87% for equity hedge funds, 3.04% compared with 7.11% for relative value funds and 2.46% compared with 7.31% for global macro/CTA funds, says the report.

According to Darolles, if a manager is already running a hedge fund, he can use the same infrastructure to run the strategy in a Ucits wrapper. This gives cost efficiencies. He calculates that the cost of regulation is around 20bp to 40bp a month. “This is a huge cost,” he notes.

“It is also relatively easy for a hedge fund manager to run the Ucits product, obtaining better results, than traditional asset managers that are not aware of specific hedge fund strategies,” advises Darolles.

“I think that skills, not only the manager skills but the management company skills on the whole, including risk management as well as marketing and all the skills involved in running the company develop a better offering for the client,” he adds.

“Investors really have to be very selective,” says Darolles. He thinks investors should be more selective when investing in global macro/CTA strategies compared with equity hedge. He advises investors to take into account the management company and its ability to work within the Ucits framework. He points out that a hedge fund management company will already have the infrastructure, team and skills to run the Ucits products and that this will have “an impact on the fund’s performance”.

The Lyxor study used the Morningstar Ucits database in a quantitative comparison between hedge fund (absolute return) Ucits and hedge funds. The cross Ucits and hedge funds database information was used to measure Ucits managers with hedge funds experience. To quantify the impact of regulation on fund returns for the strategy, the study used an empirical model that controlled heterogeneity in the different samples.

To quantify the impact of skills on funds returns with respect to the strategy, the study used an empirical model that controlled heterogeneity in the different samples.

The study used 172 relative funds, 140 equity hedge funds and 138 global funds for a total of 450 funds compared with 153 in the previous 2010 study.

Lyxor used data from Hedge Funds Research to consider single hedge funds.

Each fund was classified in one of the main Hedge Fund Research categories (equity hedge, event driven, relative value and global macro/CTA).

The study then worked on a total of 3,386 funds, with respectively a 1,636, 569 and 831 split among the three main categories of equity hedge, relative value and global macro/CTA. These numbers were in line with the ones reported in the 2010 study.

*Quantifying Newcits: 2011 Update, September 2011, by Serge Darolles, Lyxor MAP Research.

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