Managers, investors and platform providers all believe it is essential to do deep due diligence on Ucits hedge funds as well as to pay particular attention to strategy and manager selection when investing.

Chris Wyllie, chief investment officer, Iveagh Private Investment House (pictured, right)
Wyllie believes the real problem for funds of Ucits hedge funds (FoUHFs) is lack of variety in terms of Ucits hedge fund strategies. “A lot of the products that have come to the market so far are market neutral-type products. Too many products out there look too similar in terms of their risk/return profile. That’s made it difficult for people to add value through portfolio construction when they are putting together funds of Ucits hedge funds,” he comments.

Wyllie believes regulators used to be worried managers would put “all sorts of dodgy things in Ucits wrappers” but instead managers have been conservative about what strategies they put into Ucits format. “The smaller boutiques that have brought more diverse products have lacked distribution and withered on the vine. I think the market is a bit congested as a result of that,” he adds.

Barry Goodman, executive vice-president, Millburn Ridgefield Corporation (pictured)
Goodman, Millburn’s executive vice-president, says the company teamed with Deutsche bank following an extensive six-month research period speaking with a number of Ucits providers considering whether to set up the Ucits independently or on a platform. Millburn Ridgefield Corporation, a US-based $2.2 billion asset management company, launched a Ucits-compliant version of its multi-markets trading program on Deutsche Bank’s Platinum platform in June 2011. The Ucits fund was seeded with $100 million by Deutsche Bank.

“Being a US-based manager, it was important for us to partner with a major platform that had gone through its own due diligence with some of the major distributive frameworks,” says Goodman. Another key appeal of Deutsche Bank was its ability to compete on price.

“We needed an organisation with the gravitas, brand recognition, resources and experience to evolve. We needed faith and trust in that arrangement and we have a long-standing relationship with Deutsche Bank. Since we are not based in Europe, we were not prepared to take on the responsibilities associated with running our own Ucits, developing and building our own distribution mechanism. We just felt very comfortable with the relationship,” Goodman adds.

Goodman believes size matters as there are “several issues for smaller managers. If you don’t have the distribution behind it or aren’t willing to put the resources in place to support the product, you have to seriously think about whether or not to do this.”

“If I were a smaller manager, I wouldn’t rush to launch a Ucits. There are platforms that will take anyone and everyone but my guess is that there hasn’t been a lot of positive feedback about smaller managers launching on a small Ucits platform and having material success,” Goodman advises.

Goodman believes Ucits are only suitable for large US managers partnering with a big brand-name platform or large European managers that already have widespread brand recognition and the appropriate support for the Ucits fund.

According to Goodman, the “time, effort and expense [in setting up a Ucits] are not inconsequential. It’s a serious decision, especially for younger managers trying to build up a track record with scarce resources. I think it is much better trying to focus on the money management side of the business. For a smaller manager without the distributive support of a platform, it’s going to be quite expensive and quite distracting,” he notes.

Shiblee Alam, director alternative investments funds of hedge funds, Axa Investment Management
Alam believes due diligence on Ucits hedge funds should be similar to that carried out on offshore hedge funds. “Some aspects of Ucits hedge funds seem safer as they are in the onshore regulated world,” he warns. Yet “the Ucits world can be challenging for managers who are used to being offshore and operating in a less regulated universe. It is important to assess whether they have critical size – the right infrastructure, staff, skills and cost structure – to support a fund operating in a more constrained world,” Alam notes.

Axa’s FoUHF launched in April 2011 with €20 million ($26.9 million) of seed capital.

Alam believes manager selection can add value in the Ucits industry. “Just because funds are onshore and Ucits doesn’t mean performance will always be good. That’s where the need for a fund of funds comes in: choosing the right strategies and managers.”

David Armstrong, Morgan Stanley FundLogic Alternatives platform (pictured)
Armstrong has noted interest in Asia for Ucits hedge funds. Focal points in Asia for investment include Hong Kong, Taiwan and South Korea, ­Armstrong says.

He is aware of interest in Ucits hedge funds from South America, mainly wealth managers in Brazil, Chile and Uruguay. Morgan Stanley’s Ucits Fundlogic Alternatives platform is planning to launch a Brazilian long/short equity Ucits by the end of 2011.

Armstrong says demand for the platform has been strong since its launch in September 2010. The platform is currently looking to diversify by adding CTA and global macro ­managers.

Armstrong believes outsourcing the structuring of a Ucits fund to a platform is valuable for non-European managers and can be cost-efficient as the investment required to operate in Europe can be very high. Platforms can help managers avoid costs, be more productive and focus on the asset management side of running a fund, Armstrong argues, aiding efficiency.

There can also be a social aspect to being on a platform. Armstrong explains all funds on the platform are separate entities but the managers can talk to and meet with each other. Morgan Stanley sets up events such as marketing roadshows where they can share ideas. Some managers thinking about joining the platform call managers already on it to get comfort or additional information.

Ted Wong, CEO, Gottex Fund Management
Wong believes the importance of the selection and quality of Ucits managers is increasing with time. Most of the interest in Ucits hedge funds is going towards single managers. “The fund of Ucits hedge funds is still in a very nascent stage and hasn’t gained much traction,” he admits.

As daily or weekly dealing is operationally a lot more intense, Wong is wary of selecting Ucits hedge funds on second or third-tier platforms as well as funds that try and launch by themselves as they can be an “operational nightmare”. The manager, the pedigree and the risk management process are extremely important, Wong says.

Wong’s faith in the FoUHF model stems from the fact retail investors “tend to chase returns. They sometimes get blinded or romanced by the return profile of a certain manager,” Wong claims. A manager might produce outstanding returns when they are only managing $10 million of AUM, but if they start managing over $200 million and liquidity dries up, there could be a “Ucits blow-up,” says Wong.

“That is one of the true advantages of going into a FoUHF. I would not be surprised after a Ucits blow-up or big liquidity mismatch, lots of investors start turning to FoUHFs. There are a lot of second and third-tier Ucits funds out there,” he cautions.

“Any educated investor realises there are extra layers of costs involved with Ucits funds as the use of leverage and shorting are limited at times,” says Wong. Swap costs, administrative costs and platform costs tend to be higher for Ucits funds, he adds.

Cédric Lamielle, founding partner, Casteel Capital
Lamielle looks for hedge fund strategies that fit well into Ucits – largely equity-based, event driven and statistical arbitrage strategies. He believes the global macro offering in Ucits format is disappointing because the most established macro funds are closed or don’t need to raise assets. Lamielle adds that most macro funds are US based and US managers are only just familiarising themselves with the Ucits universe.

Casteel Capital’s FoUHF launched in June 2010 with €56 million of AUM. Assets have since risen to €63 million, largely coming from European family offices attracted to the liquidity profile of the fund. The FoUHF has 20 underlying Ucits hedge funds and its primary goal is capital preservation. Lamielle has no preference in terms of domicile when looking at Ucits funds for his FoUHF. “Luxembourg and Ireland are the biggest, but France and Germany are strong domiciles as well. It doesn’t matter to us where the jurisdiction is as long as it is a recognised jurisdiction,” he says.

Lamielle says due diligence on Ucits hedge funds is as important as in the offshore world – “just because it is Ucits doesn’t mean you can be light on due diligence,” he affirms.

Casteel typically spends six months vetting new managers to complete a quantitative review of their portfolio and see if it makes sense in its own portfolio. It is also necessary to carry out due diligence on both the service providers and the counterparties, Lamielle adds. Making sure the fund is running a good business and hiring the right people is another factor Casteel looks at closely.

Understanding the true liquidity of Ucits funds is also crucial for Lamielle who readily admits to his “obsession” with the underlying liquidity of his FoUHF.

A knock-on effect of Asian interest in Ucits hedge funds could be a new source of investment for FoUHFs. Lamielle believes Asian interest in FoUHFs is beginning to rise but investment may take a while to come through as Asian investors often require at least three years’ track record and $100 ­million AUM.

Miriam Muller, head of Merrill Lynch Investment Solutions Ucits platform, Bank of America Merrill Lynch (pictured)
Muller says investors should ask all of the same questions they would for an offshore fund and more when doing due diligence on a Ucits hedge fund. She believes it is important to look at the way the fund is structured and which instruments it uses. “Is it a bottom-up replication of a fund or a structured version with an index? Is it really diversified? To what extent does it mirror the flagship fund if there is one?” are key questions she identifies for investors to ask Ucits hedge fund managers.

Investors should ask specifically about the Ucits rules, what kind of pre-trade compliance checks and post-trade reporting the fund has and what the methodology for resolving any breaches is, she adds.

According to Muller, US-based managers are increasingly approaching BAML platform about joining. The platform is unashamedly selective. It has strict criteria when considering funds to join the platform. All funds must have: a good brand name; three to five years’ track record; good performance compared with its peer group; limited correlation to markets; strong demand for the strategy, and the ability to fit in the Ucits format.

Although Muller admits brand name is not absolutely crucial, it is important and helps a lot. “Offering a fund from a widely recognised manager helps the sale because the fund is already familiar with lots of investors. If we think there’s a great fund managed by a great manager who is relatively unknown, we wouldn’t rule it out,” she adds.

Mark Mannion, head of relationship management for Europe, the Middle East and Africa, BNY Mellon Alternative Investment Services
Mannion does not believe the European investor market is completely saturated for Ucits hedge funds. “The amount invested in Ucits hedge funds by European investors remains a relatively small proportion of the overall market. It does appear that the inflows emanating from European institutions to the Ucits hedge fund market are increasing and therefore there are ample growth opportunities in Europe,” he says.

Mannion adds that “the overall FoHF industry in Europe has yet to recover from the financial crisis when issues around liquidity and transparency came to the fore. This combined with the fact that the underlying [Ucits] universe has yet to reach critical mass will mean that it will be some time before this industry blossoms.”