Are Hedge-Fund UCITS the Cure-All?

Are Hedge-Fund UCITS the Cure-All? — March 2010

3. Structuring HF Strategies as UCITS

In addition to the absolute VaR constraint, stress tests are generally required (in Luxembourg and Germany they must be done at least once a month). The relative VaR limit is deemed important for sophisticated UCITS that self-classify as traditional investments such as money- market funds or fixed-income products. The relative VaR criterion is usually less relevant for hedge-fund UCITS because they do not fall into traditional investment categories, as pointed out by 80% of respondents to the EDHEC survey (85% of AIFMs, 85% of fund investors). After all, hedge fund strategies are generally marketed as diversifiers, so hedge funds are rarely interested in using traditional benchmarks and relative VaR constraints. 5 Unlike relative VaR, the absolute leverage constraint is mandatory for all funds. We discuss our proxy for the measurement of the VaR of hedge fund strategies in greater detail in appendix 2. Investment funds may measure their Value-at-Risk with historical Value- at-Risk, i.e. , using the actual fund position and historical daily market data to simulate the maximum historical loss given by their current strategy. Because hedge fund databases provide only monthly fund returns, we estimate the Value-at-Risk of each fund with sample VaR and Cornish- Fisher parametric VaR, a measure that is based on a Taylor development of the cumulative distribution function. Box 5: Quantitative VaR assessment: How many strategies would pass the test?

In our case, we simply use the first four moments, which leads to the following development for our P distribution. Statistical problems with these measures, the proposed corrections and the details of our calculations are presented in appendix 2. For the 1988-2009 period, we select at each date the funds that have at least sixty return points, that is, five years of complete data. All graphs show statistics on an equally weighted basis. After all, most indices of hedge funds are constructed with equal weighting. We show figures for the following categories: CTA/CPOs (commodity trading advisors/commodity pool operators), Equity Long/Short (incl. emerging), Global Macro, Relative Value, Event Driven, and Fund of Funds/Multi- Strategy. The number of strategies at the end of 2009 are as follows: Event Driven and Global Macro are largely underrepresented (and even more so at the end of the sample illustrated in the figure below), so for these strategies an event concerning a limited number of funds may be very visible in the statistics—in figure 21, the fraction of funds that passes the UCITS VaR requirement goes easily from 0 to 50%. Number of funds (% total) CTA/CPOs 346 16% Figure 20: Funds with five years of available returns, as of November 2009

5 - If needed, a UCITS may take an equity or corporate bond benchmark, where twice the VaR is over 20%, so as to keep the relative VaR constraint from being binding.

Fund of Funds/ Multi-strategy

1050

48%

Equity Long/Short (incl. emerging)

33

2%

Global Macro

6

0%

Relative Value

737

34%

Event Driven

7

0%

Total

2179

100%

33

An EDHEC Risk Institute Publication