28/10/2009

The UCITS states of America

In June, York Capital Management, a hedge fund management firm in New York with $10bn under management, joined the parade of large European managers that have flooded the market with Ucits III fund products this year. Until then, US hedge fund managers had, by and large, ignored Ucits vehicles.

"Now, US aloofness is giving way to increased interest, as they seek to replenish depleted coffers, compete with their European counterparts, and anticipate new EU regulations that will make it difficult to sell offshore funds into Europe. Attorneys and consultants to these managers say that a surge in Ucits products from US firms is in the offing"

“I believe that within five years, every large and established US hedge fund company will have a Ucits product,” says Norman Chait, the managing principal of Nardis Advisors, an investment advisory and consulting firm in New York that advises on Ucits structures. Many US managers are looking to Ucits products as a way to raise assets offshore. “These are big funds looking around for money, and Europe has been a source, through individuals or pension plans, and they want to have access to those pools of capital,” says Timothy Clark, a partner at the New York law firm Proskauer Rose.

John Donohoe, president of Carne Global Financial Services in Dublin, agrees. “From a pure business perspective, some of them have been struggling and hence looking at new ways to raise assets,” he says. Ucits products, he notes, can be sold just about anywhere in the world outside the US, and are especially attractive to European pension funds and high-net-worth Asian investors. Indeed, 40% of recent Ucits sales are from outside the EU, with these funds being offered in 140 countries, according to Chait.

Another factor looms large in US managers’ strategic planning. If the proposed EC Directive on Alternative Investment Fund Managers (AIFM) is enacted in two years’ time, it will become more difficult for US managers to raise assets in Europe. “You won’t be able to go to Europe the way you used to and market a Cayman-based fund,” says Chait.

The Directive, still in draft form, will lay down principles around such things as administration and leverage levels, according to Donohoe. Those that don’t comply with its tenets will not enjoy passporting, but will be dependent on domestic countries allowing private placement products. “A lot of people believe those that are compliant won’t be allowed to sell directly to the public, but will be allowed to sell to more sophisticated investors and in a much more open way,” he says.

This means that different levels of certainty and distribution ability will exist. “So, with Ucits, high levels of distribution to end-product channel,” says Donohoe. “Everybody is agreed that a Ucits fund can be sold throughout Europe under the Ucits passport, and it can be sold to both institutions and the public,” says Donohoe.
Hence, US managers’ interest in Ucits funds. “The EU draft proposal now says that if you’re a US manager trying to raise money in the EU, you’re going to be forced to register in the EU and be subject to the capital requirements,” says Clark. So, US managers figure that if they are going to have to register anyway, “they might as well start looking at the Ucits products,” he says.

Competition is yet another reason

US managers are looking to roll out Ucits funds. “If a European investor has a choice between a Ucits long/short fund with weekly liquidity at 1.5/20 over a hurdle versus paying 2/20 for a Cayman-based long/short fund, all things being equal, they’ll go with the European fund,” says Chait.

Furthermore, “many pension schemes in Continental Europe can only invest in domestic funds of hedge funds (FoHF), and they are prohibited from going directly into hedge funds in a meaningful way,” says Donohoe. “However, they can invest as much as they want into Ucits funds; so it’s a brand new market for the hedge fund world.”

It’s also important to offer tax-efficient products in Europe, those that have “distributors’ status”, According to Donohoe, Ucits funds have a tradition of obtaining distributors’ status, which allows returns from hedge funds to be taxed under a capital gains regime rather than an income tax regime. FoHFs that hold Ucits funds can also get distributors’ status, he says. “Any manager that wants to tackle the wealth space in particular has to be ready for the onslaught of Ucits funds of hedge funds,” says Donohoe. “In other words, they have to be able to offer a Ucits hedge fund product in that space.”

These considerations informed York Capital’s decision to launch a Ucits fund. “Many traditional asset management clients are looking for investment vehicles that can access alternative investment strategies in a registered fund format with regulatory oversight, independent administration and risk management,” says Jeffrey Weber, president of York Capital. “There is a universe of Ucits III investors that cannot invest directly in hedge funds. We view the new fund as broadening our overall investor base to include many categories of investors that would not be eligible to invest with York Capital in a traditional hedge fund structure.”

However, launching a Ucits hedge fund is not for the faint-hearted. A US manager’s upfront costs for a Ucits fund are substantially greater than a traditional hedge fund domiciled in the US, says Clark. Besides the cost of paperwork, there is setting up a whole infrastructure in Europe. As well, most managers, whether they’re in Ireland or Luxembourg, will have capital requirements – there are no capital costs to be an investment advisor in the US.

The big issue for US managers wanting to offer Ucits funds is that they need to have very tight compliance departments and risk management. The process lends itself to larger firms that are registered with the SEC, as they will have compliance infrastructures in place and be attuned to meeting regulatory requirements; however, they will get no special breaks from the EU. In turn, these factors mean smaller hedge funds will find it very difficult to access the Ucits market.
Another essential expense is distribution, the key to success for a Ucits fund. “Ucits is a model where people have to pay distributors,” says Chait. “Once you’ve got a superior delivery mechanism, an average fund with a superior delivery mechanism will always raise more money than a good fund with a lousy distribution mechanism.”

York Capital uses the Merrill Lynch Investment Solutions, a Ucits-compliant platform, as its sponsor.
This allows the firm to tap Merrill’s vast clientele. “US managers that are interested in selling outside the US should at least be examining the alternatives directive and Ucits directive and how it can help their business,” says Donohoe.