21/07/2010 Author: Tony Griffiths

Newcits: A warning sign?

The popularity of Ucits-compliant hedge fund strategies has swelled over the last year, attracting both institutional and retail investors. But have May and June's performance wobbles brought Newcits expectations back to reality?

If an explosion of activity characterised the Ucits-compliant hedge fund space in the latter stages of 2009, early 2010 will be remembered for the first dark clouds of regulatory concern. After months celebrating what was proving to be a profitable union of hedge funds managers and a brand new avenue of investment, the issue of “potential threats to retail investors”, as PricewaterhouseCoopers put it in a March report, had brought rain to the parade.

“We want to make the sure the products are as well explained as possible, otherwise we are heading for a mis-selling situation,” said Jean-Baptiste de Franssu, president of the European Fund and Asset Management Association, in the week after the PwC paper’s release. The warning would be echoed by a number of de Franssu’s peers, before being reiterated by the man himself as recently as this week.

Had Ucits-compliant hedge funds – or ‘Newcits’ as the media has since dubbed them – been exposing unsophisticated investors to an outdated definition of absolute return? If mis-selling had taken place, May’s financial market crash brought any inflated expectations back down to earth with a bump. According to Chicago-based data provider Hedge Fund Research (HFR), the average Newcits fund lost 2.7% in May and a further 0.38% in June. A tough January had been offset by a strong March. Although, with May and June factored in, the average Newcits fund is down 0.35% for the year, HFR data showed.

“It’s been a wake-up call for investors but I don’t think it’s a watershed moment,” Paul Graham, head of global alternatives at Gartmore, says of May/June Newcits performance. “Some retail investors have higher expectations of Ucits products because of the way some people have promoted them thus far. It’s probably a good thing that it’s happened for some Ucits investors.”

During the difficult May/June period, Gartmore’s Newcits range – which replicates the performance of their hedge fund equivalents almost completely – was flat to slightly negative, Graham reveals, although the Ucits version of the firm’s AlphaGen Capella long/short equity fund was down 2% across May/June, hitting its maximum draw-down for the first time in its 11-year history. Gartmore’s Newcits funds still outperformed the average Newcits and hedge fund, as well as the equity markets, which plummeted around 10% across the same period.     
“There has been some disappointment, though, having said that, you’ve got a massive standard deviation event in May,” he says. “For the vast majority, the Ucits strategy has done well. If you are down 1% to 4% in a market that’s down 10%, that’s a pretty decent job.”

If disappointment has been expressed at Newscits apparent inability to outperform the wider hedge fund industry (HFR’s composite index is down 0.18% YTD, compared to -0.35% for Newcits only), the picture improves once the data is analysed further, as HFR’s chief executive, Ken Heinz, explains. “When you strategy-normalise the performance of the Ucits funds vis-a-vis the entire hedge fund universe, the Ucits funds did better, given the fact that that universe is heavily weighted towards macro and equity hedge, which have been the areas of the industry that have been the weakest in both May and June and the first half of the year,” he says.  

Heinz estimates that equity hedge and macro Newcits account for around 80% of the entire Newcits universe. The HFRI Equity Hedge Index fell 3.69% in May and is still languishing on -1.60% YTD, while the HFRI Macro index has fared little better, down 1.21% in May and 1.27% YTD. In fact, the two areas of the industry considered the least likely to have a highly liquid or risk-modified version of the strategy to offer to investors, relative value and event driven, are among the year’s best-performing strategies, up 3.66% and 2.43% respectively.

“There shouldn’t be anyone that has a correctly calibrated expectation that has a dynamic of disappointment associated with that,” says Heinz.

Certainly there is evidence that the May/June downturn hasn’t sated the appetite for Newcits products. “It hasn’t stopped the interest at all,” says Christopher Day, a director at Merchant Capital, provider of a recently launched Ucits platform. “We’re getting more calls increasingly as the year has gone on and it hasn’t stopped. If anything, it’s still getting bigger. The momentum is very strong.”

Merchant Capital’s Newcits platform went live with its first fund at the end of January. AuM is currently only €2m ($2.59m), but, with a number of new funds and investors already signed on, Day estimates that the platform will top €170m ($220.74m) by October.

The inflows story is slightly different at Gartmore. After strong quarters either side of the New Year – during which the firm saw “massive inflows” into its European and UK absolute return products, says Graham – activity has flattened somewhat. While the suspension at the end of March of star manager Guillaume Rambourg, and his subsequent resignation last week, contributed in part, the trend has been sustained by the wider macro factors.

“We’re flat because the market’s flat – everybody’s risk averse and running for the safe havens,” Graham explains. “We think it will all take care of itself through the summer and come September we’re very positive on the Ucits and hedge fund space.”

A key difference between Gartmore and Merchant is their relative investor bases. Asset manager Gartmore relies heavily on the retail market for Newcits investment – nearly 100% according to Graham, with zero from institutions. Merchant, a more boutique operation, has had more institutional interest. Not only that, but, unlike Gartmore, Merchant Capital doesn’t sell to deep retail – the ‘Mr and Mrs Smiths’ of the investment world.   

“If you look at fund flows from the retail world, they do come in and out quite quickly, “ says James Orme-Smith, formerly with Deutsche Bank as head of the firm's Ucits platform. “The market is probably split 60/40 between retail and institutional. But if you look at who raises the money from retail, it’s the asset managers. The generic boutique hedge fund Ucits strategies, meanwhile, are not raising money from retail, they’re raising money from the likes of funds of funds.” Interest in the Deutsche Bank platform “is still very high”, he notes.

HFR’s own investigation into Newcits inflows has revealed the scale of the recent boom. Giving HFMWeek a preview of the findings, Heinz said HFR currently estimates the Newcits universe to oversee AuM of around $80bn and that it is “very likely” to exceed $100bn by the end of 2010. Based on the data provider’s last estimate back in February, inflows in the last six months stand at around $25bn into Newcits alone, while the number of funds has doubled from around 200 to 400.     

Concerns voiced by regulators that some investors may have built up unwieldy expectations of Newcits funds may have been proved true to a certain extent, but cases are few and far between and limited to the retail arena. However, any thought that the downturn in May and June – the first serious blip during the Ucits boom – would derail the process looks to be wide of the mark, as Orme-Smith concludes. “It’s dependant on the country and the investor type, but, generally speaking, interest in Ucits hedge funds is still very strong and this is being backed up by very good performance relative to hedge funds and to the long-only world.”