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Sep 23 2011 | 9:42am ET
UCITS hedge funds haven’t been around long enough to make any definitive statements about their usefulness, but Investcorp’s Ludger Hentschel says their recent performance suggests the “hamstringing” of these highly regulated products produces lowers performance.
Hentschel, a principal and head of quantitative research and asset allocation for Investcorp’s hedge fund team, made the comments during a panel focused on alternative hedge fund structures at last week’s FINforums Annual Hedge Fund Summit in New York.
Hentschel characterized UCITS as a regulatory framework “popular in Europe” that allows hedge funds to market their products to a much wider audience than they currently can under a traditional hedge fund structure. To do that, however, funds must comply with “very restrictive terms.”
“They have to offer very generous liquidity terms—generally speaking, 14 days’ notice,” said Hentschel, which is “nothing like the typical hedge fund and probably completely incompatible with the less liquid hedge fund strategies, like distressed investing, or even event-driven investing.”
“It severely limits leverage—gross exposure inside a UCITS structure cannot exceed 200% of assets, that means you’re restricted to fairly liquid assets but can’t lever those up. The typical hedge fund that trades liquid assets does so with leverage.”
In addition, UCITS funds restrict portfolio concentration, limiting the percentage of securities that may be held from any one issuer (with the exception, as Hentschel pointed out to laughter from the 160-member industry audience, of “really safe instruments like European government bonds”).
In short, he said, within UCITS you “can’t run a levered or a concentrated portfolio and I think that precludes a lot of the strategies hedge fund managers pursue.”
(That certainly proved true for BlueCrest BlueCrest Capital Management which decided in late 2010 to pull the plug on its $630 million BlueTrend UCITS Fund on that grounds that it had failed to accurately track the $9 billion BlueTrend fund—and that the disparity was likely to worsen.)
Nevertheless, Hentschel said there had been “an absolute explosion” in the number of offerings in the UCITS structure. Despite the large number of UCITS funds, however, he cited AUM estimates in the “$100-$150 billion” range.
Fellow panelist Meredith Waterman, co-head of managed account strategy with Man Investments, said she felt these AUM figures have disappointed observers:
“I think…when UCITS funds were launching there was tremendous expectation around target AUM for each product, and I don’t get the sense that those products have hit their targets.”
As to whether they perform better than hedge funds, Waterman said the constraints on UCITS products as outlined by Hentschel “create a completely different hedge fund than the fund that you were trying to replicate, the flagship fund, and so, because of their differences, the performance is going to be different…I know the evidence has been that UCITS funds have not performed as well as hedge funds have since their inception.”
If Hentschel and Waterman had a favorite alternative hedge fund structure, it would have to be managed accounts. Certainly, these vehicles are extremely popular among institutional investors. “We have not only seen an increase in investor interest in managed accounts, but have experienced growth in this product as compared with our other multi-manager products,” said Waterman.
The reason? According to Waterman, it’s “because of the benefits around transparency, liquidity and control.” And of these three, transparency is key.
“With a managed account structure you generally get daily transparency of positions across all of your hedge fund investments. The liquidity is a tremendous benefit because you can monitor the true liquidity of a portfolio based on having that transparency of positions, and you know that liquidity is generally dictated by the market as opposed to the managers [as it would be] in true, traditional hedge fund investing.”
Hentschel, while agreeing, added that “liquidity” with managed accounts doesn’t necessarily mean daily liquidity—the statutory liquidity for managed accounts often matches that for the fund—but the ability, if necessary, to dismiss a manager from an account and liquidate it “in an orderly fashion.”
As for managed account performance, Hentschel said Investcorp has done extensive research based on its own long experience with managed accounts and has found that they have outperformed comparable funds.
Investible Hedge Fund Indices
Speaking on behalf of yet another alternative hedge fund structure, investible indexes—Adam Patti, CEO of IndexIQ, began by declaring himself “pro-hedge fund.”
“I think hedge funds are great diversification tools for advisers and their investors,” he said, “but when you look at the hedge fund marketplace, it looks very much like the mutual fund market looks today, with 10,000 funds.” He explained that in the mutual fund marketplace, the vast majority of active mutual fund managers fail to outperform their index benchmarks each year. “Given the maturity of the hedge fund market, the same relative underperformance argument holds.”
What hedge funds overwhelmingly provide however, in contrast to traditional mutual funds, said Patti, when you dissect the overall market and analyze the risk-return patterns, is “a lot of beta exposure,” or “alternative beta.” However, he said, this “alternative beta” is attractive for portfolio diversification. “The question then is whether you need to pay alpha fees for beta performance; and the answer to that question is that you do not.”
“What has been proven, originally by the academics studying the issue, and then with real world product performance, is that you can replicate this ‘alternative beta’ exposure of hedge funds using common liquid securities in the marketplace—derivatives, individual securities, or in our case, ETFs,” said Patti, which allows investors to reap the benefits of liquidity, transparency, low fees and tax efficiency. He added that although IndexIQ’s market focus is “not necessarily institutional” the products are “institutional quality” and Investcorp’s Hentschel agreed:
“We think that institutions might have interest in this, in particular to try to manage short-term, liquidity-driven trades where they have excess cash that they would like to deploy in hedge funds without incurring the cash drag that they would normally have. Anybody who manages a hedge fund portfolio encounters this all the time, where they redeem from one fund and the cash sits around for a few days or a few weeks before they can actually subscribe to another fund. One of the attractions of these vehicles is that they’re extremely liquid…intra-daily liquidity, potentially, and can serve that need.”
Patti characterized IndexIQ as “the S&P 500 of the hedge fund market.”
“Our products provide the diversification benefits of investing in hedge funds, without the structural impediments of the hedge funds themselves,” he said. “Our track-record is the longest in the industry, and in fact our mutual fund Ticker: IQHIX was recently rated 5-Stars by Morningstar.”
Summing up his firm’s products and other similar investible hedge fund indices, Patti concluded: “We are not looking to out-alpha the alpha providers. We provide a core, cheap, alternative beta selection for your portfolio and then if you have the skill and the access, you go out and you find those alpha producers.”