Increasingly popular pan-European UCITS funds are a valuable part of any investor’s toolkit but they are not without their own risks and should be carefully scrutinised, according to the results of a survey by
Alternative Decisions, a European consultancy.

UCITS III funds, which are structures enabled by European Union rules in the noughties, allow managers to use derivatives to take short, as well as long, market positions – a freedom once the sole preserve of hedge funds. UCITS funds are regulated and offer high levels of liquidity, which is attractive to investors fearful of being unable to withdraw money from a hedge fund, as happened when funds shut the exits amid the credit crisis over a year ago. There have been a number of launches: for example, UK-based Toscafund recently launched a UCITS III version of one of its funds. Other firms rolling out these vehicles include Castlestone, Legal & General, AllianceBernstein, Gartmore and Aegon.

However, the rush of interest in issuing UCITS “hedge fund-lite” products has encouraged firms to warn about whether these vehicles carry certain risks. Collins Stewart Fund Management recently called for investor caution over UCITS funds.

“The [survey] results show that there is massive UCITS potential but it should be seen as a complement to other funds and not a direct replacement of offshore structures. The technical and distribution challenges warrant fund managers adopting new marketing techniques and understanding their education responsibilities,” a report from Alternative Decisions, called Better UCITS Hedge Funds, said.  

“The current euphoria for UCITS needs to be married to education and technical know-how. UCITS is a great brand for certain hedge fund strategies but successful asset attraction demands new marketing and distribution techniques,” said Lawrie Chandler, co-founder of Alternative Decisions.

The Alternative Decisions survey was drawn from about 70 European respondents comprising institutional investors, asset managers and other service providers.

The survey’s findings include:

UCITS funds appeal to most investor classes equally, be it retail investors or institutions.

Suitability of strategies for UCITS is where product developers need to be honest. The risk from financial engineering and shoehorning strategies into UCITS is considerable.

Tougher regulation and transparency are here to stay.

UCITS is a sister to offshore structures, not a replacement.

Understand the ongoing shift in rules and additional operating expenses. Operate within the spirit as well as the rules.

Alternative Decisions is a subsidiary of eHedge, a European based consultant and performance tracker based in Germany. The group was founded in 2000 by bmp Venture Capital and LCF Rothschild, among others.