Are Hedge-Fund UCITS the Cure-All?

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

3. Structuring HF Strategies as UCITS

funds of alternative funds to be distributed as regulated funds to high net worth individuals or even as retail funds. But the same is not true for coordinated funds, and the intuition that the diversification offered by funds of funds makes them naturally compliant with UCITS regulation is mistaken. It is perhaps for this reason that the majority of respondents think that Funds of Funds and Multi-Strategy will be far more eager to domicile in Europe than to restructure as UCITS. The UCITS directive indeed restricts investment in other funds; it requires that target funds be supervised in much the same way as UCITS, 11 and that the cumulative investments in non-UCITS funds amount to no more than 30% of the value of the fund, so the bulk of the performance must be accessed via derivatives on hedge fund indices. One possible means of structuring Fund of Funds strategies as UCITS would be to invest solely in UCITS hedge funds, thereby creating funds of UCITS (or UCITS of UCITS) but that would then involve piling up costs inefficiently. If the value added of a managed fund of hedge funds consists mainly of fund selection, restricting the available target funds to UCITS alone clearly diminishes the possibility to create value in funds of hedge funds, and UCITS of UCITS should not be favoured. Funds of hedge funds, for instance, might be structured as regulated funds of alternative funds. After all, many domestic regulations authorise the distribution to all investors of such funds of funds.

mechanism for sharing default risks on derivative contracts among a coalition of financial intermediaries ( e.g ., banks). In a CCP arrangement, if one member of a CCP defaults on its obligations, the CCP, and hence the other non-defaulting members, assume these obligations. In this way, default losses are shared among the firms that belong to the CCP. Since sharing of risks can reduce the costs of bearing them, at first blush a CCP has much to offer”. For individual banks the costs may be high, but, as Pirrong (2009) argues, CCPs will relieve end-users of derivatives such as institutional investors 10 and asset management firms of some of the counterparty risks of derivative instruments. In addition, counterparty risk management and collateral management will be less demanding, and will result in lower internal and depositaries costs. CCPs will allow UCITS (candidates) to invest freely in derivatives without any quantitative restrictions stemming from counterparty risk. c) Funds of Funds and Multi-Strategies Funds of funds and multi-strategy funds pool strategies, sometimes adding a layer of dynamic investment strategies. With the exception of multi-strategies that are built by a multi-disciplinary team, these strategies involve investment in other (target) funds. Fund of Funds and Multi-Strategies are consistently viewed as one of the strategies that will be the most relocated to Europe. After all, most European regulations allow

10 - There is a social benefit insofar as risk-hedgers will see their default risk reduced during times of financial distress when they precisely need protection that derivatives products offer. 11 - In practice, this requirement as spelled out in article 19 seems not always to be enforced. Failure to comply, however, is always a risk.

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An EDHEC Risk Institute Publication