Schroders, with just under £200 billion under management, launched its Global Alternative Investor Access UCITS platform in 2009. Since that time, it has offered only five funds under it—most recently, the Schroder GAIA CQS Credit fund. FINalternatives Senior Reporter Mary Campbell spoke with Eric Bertrand, director of Schroders NewFinance Capital (a fund of hedge funds) and of Schroder GAIA, to find out why Schroders likes UCITS funds and which hedge fund strategies are most easily regulated within this framework.
Are UCITS funds becoming more popular?
Eric Bertrand: It’s clearly, in my opinion, gathering momentum. Sales of the products we have are growing month by month. I can see no reason for this stopping. The UCITS environment is extremely beneficial and of high interest to investors, especially in Europe, but also in Asia and possibly Latin America. It’s vehicle that addresses concerns that many European investors have with offshore structures.
When you say UCITS funds are “extremely beneficial” to investors, what do you mean?
Bertrand: You have a much stronger vehicle from a regulatory and governance point of view than most offshore vehicles. There are more independent actors in the structure than you have in an offshore product. Also, for European investors—ranging from retail to the affluent and institutions—there is a distrust of offshore structures. It’s clear with some institutional investors, especially in France and Germany, that being invested in the Caymans or similar offshore centers is something people don’t want to be seen doing, even though it’s not forbidden. So you have all these pressures that militate for this environment. Also, the UCITS brand has built a 20-year reputation, which gives people more comfort.
What effect will the European Union's Alternative Investment Fund Management directive have on the popularity of UCITS funds?
Bertrand: AIFM is an important development because it’s quite prescriptive and managers and investors alike will have to heed it and take notice. The way I see things, AIFM will take some time to develop because it is not yet fully documented. The timeline to get compliant with AIFM is several years down the road. I would see the market in Europe segmented in two, with the liquid strategies in UCITS structures and the less-liquid ones that cannot be sensibly replicated in a UCITS structure migrating to the AIFM format. I also believe that AIFM funds will remain an institutional-only market, by and large.
What criteria do you use when choosing strategies and fund managers?
Bertrand: NewFinance is in essence the hedge fund investment arm of Schroders, which Schroders acquired about five years ago. We have added three externally managed funds to our platform since we launched it a year and a half ago, and we have some 100 investments in our funds of funds. In general, we apply similar investment criteria for selecting a fund for our GAIA platform as we would for our own portfolios. But there’s an additional set of criteria
The first criterion is capacity. If we were to launch a fund with a capacity of $100 million or $200 million, it would not be worth the opportunity costs of doing this versus selling other products. So, we look for managers with a capacity of $1 billion. We need to be comfortable that the manager has experience in managing assets of that size. We are actually already restricting ourselves to already fairly large managers, i.e. managers who will manage some $3 billion or more.
Another key criterion is operational. We expect managers to have some fairly substantial operational back-office and middle-office teams.
How do you decide which strategies and managers to add to your UCITS platform?
Bertrand: We have so far been working with two criteria. First, it is important for us to start with offshore strategies that could be replicated in the UCITS world without any meaningful tracking error, those that we could back-test and be comfortable that they were already fit for UCITS. Many long/short funds are perfectly suited for that. Going forward that will change as we look for offshore strategies that are not as straightforward to replicate in the UCITS structure.
The second criterion is exclusivity. We won’t have two managers on our platform that do the same thing. For example, we have just launched a European long/short equity fund, so we won’t have another competing strategy on our platform. That’s the commitment we offer managers. In exchange, we ask them not to offer the same strategy in UCITS through other channels.
These criteria limit the number of managers we will have on the platform as we won’t have more managers than there are hedge fund strategies. You’re not likely to see more than 10 to 12 managers on the platform when it’s fully populated, unless we go into more exotic strategies down the road.
In addition, we are likely to take a tactical approach and go with the strategies we think will perform reasonably well at a given stage in the cycle. For example, we’re in an environment where all investors have questions about interest rates. Offering a product that has no directional bias, either long or short, is an attractive alternative to holding long-only credit investments in this environment.
Finally, we want to offer strategies that are not currently part of Schroders offering and will therefore broaden the range of investment products we offer.
What type of funds lend themselves best to the UCITS framework?
Bertrand: The main criterion is liquidity. UCITS requires funds to offer liquidity at least twice a month. We believe it needs to be at least weekly, and some will be daily. It depends on the strategy.
Not all strategies can offer weekly liquidity. A small-cap merger arbitrage manager, for example, cannot offer the liquidity that’s required in UCITS. The same is true for many areas of the credit space, such as securitized or distressed debt.
On the other extreme, large-cap equity strategies, both long and short, are easy to replicate in a UCITS structure. I can think of many U.S. long/short managers who have quarterly liquidity, but who could very well offer weekly liquidity, if investors demanded it. The underlying portfolios are liquid enough to be able to cater to this type of highly liquid requirement.
From an investor relations perspective, you have to explain that the manager can still deliver what he has offered. That task is not easy because you can’t transpose an offshore track record directly into the UCITS space as the manager has altered his investment strategy.
On a case by case basis, I can see tweaking a strategy in order to make it UCITS compliant as long as all parties involved — the manager, the sponsor, the distributor and the clients— are satisfied that the return potential, which will differ somewhat from than the offshore flagship fund, makes sense as an investment proposition under UCITS.