In April 2014, the European parliament voted to adopt the UCITS V Directive, with the new rules widening the scope of protection to investors, and bringing the regulation closer in line with the AIFMD. The regulatory framework acts as a quality control on transparency, risk management and liquidity of funds, which can be attractive to some investors. This blog will take a closer look at UCITS investors, and touch upon the future of the structure.
Unsurprisingly, given the origin of the regulation, the majority of investors that utilize UCITS hedge funds are from Europe, with the region accounting for 87% of active UCITS investors. However, the structure has some demand in North America and Asia-Pacific, with these regions representing 8% and 3% of UCITS investors respectively. Certain investor types are more prominent within the UCITS industry; notably, fund of hedge funds managers account for 51% of UCITS investors tracked by Preqin’s Hedge Fund Investor Profiles, compared with 18% of the wider hedge fund investor universe. UCITS fund can be attractive to fund of hedge funds managers that need to meet liquidity requirements and re-allocate capital on a regular basis.
Liquidity and investment horizon appear to be key factors in determining the types of institutional investors that utilize UCITS structures. This can be seen with the relative proportion of asset managers and wealth managers that invest in UCITS funds, with these types comprising 12% and 10% of UCITS hedge fund investors respectively (compared to the 4% and 5% they represent of the wider hedge fund universe). These investors typically invest on behalf of their clients and these clients may often demand more liquidity from their investments. In addition, banks, which have come under regulatory scrutiny and have strict liquidity requirements, make up approximately 5% of UCITS investors, compared to 1% of hedge fund investors overall.
Conversely, a lack of demand for UCITS hedge funds can be seen in investors with longer investment horizons and less need for liquidity. Private sector pension funds and public pension funds, account for 5% and 4% of UCITS investors, compared with 16% and 9% of hedge fund investors respectively. Pension funds typically have longer investment horizons in order to meet long-term payment obligations and therefore less immediate need for liquidity. For this type of investor the UCITS wrapper can have some limitations and this may be preventing some from investing in the structure.
Increased regulation and compliance tends to inhibit returns due to the limiting of possible investment opportunities. For example, event driven strategies, which have posted strong returns over the past year, are not fully compatible with the UCITS wrapper due to the liquidity requirements. According to Preqin’s Hedge Fund Analyst, UCITS funds posted returns of 7.22% for the 12-month period ending 30 June 2014, compared to 11.21% posted by the hedge fund index. Despite this, the indication that UCITS funds are keeping pace with offshore hedge funds should be encouraging to investors who prioritise increased regulation and liquidity over performance.
Data in the recently released Investing in Hedge Funds: All About Returns? report revealed that as little as 7% of investors invest in hedge funds purely for high returns. Most investors instead look for uncorrelated returns, attractive risk-adjusted returns and reduced volatility, all of which could apply to UCITS funds. The findings suggest that UCITS funds are well placed to capitalize on current investor attitudes. However, UCITS investments remain a relatively niche aspect of the hedge fund industry. Approximately 10% of hedge fund investors tracked by Preqin plan to allocate to UCITS structures over the next 12 months and it will be interesting to see whether this proportion increases as investor attitudes towards the role of hedge funds within their portfolios continues to shift.