Has The UCITS Had Its Day?
Thursday, June 09, 2011

While hedge fund managers will continue to create European Union-domiciled hedge funds to complement their Cayman Islands or other offshore offerings, Irish Qualified Investment Funds (QIFs) and Luxembourg Specialized Investment Funds (SIFs) are gaining popularity versus the UCITS framework, according to the findings of new research.

A survey report released on June 6 by RBC Dexia and KPMG challenges the notion that onshore domiciles could rival the supremacy of the Cayman Islands amongst hedge fund managers.

“The survey shows that EU fund domiciles are becoming more and more relevant to the hedge fund community, and that they respond to a real need amongst clients for more liquidity and transparency," commented Jean-Michel Loehr, Chief of Industry and Government Relations at RBC Dexia.

Only a quarter (24%) of hedge fund managers said that they had already brought offshore funds onshore. Of those, more than half (55%) said they opted for co-domiciliation by creating onshore clone funds to complement their existing Cayman or other offshore offerings. Less than 5% of those with onshore funds said they had decided to transfer the domicile of their funds to the EU outright. The trend for hedge funds to create more EU regulated funds seems set to continue however, with 27% of respondents stating that they are considering doing so.

"Co-domiciliation allows hedge fund managers to cater to investors that are not authorized to buy into Cayman funds with onshore products while retaining their existing offshore strategies," Loehr observed.

However, the uncertainty over the Alternative Investment Manager directive, approved by the EU last year, means that the trend towards co-domiciliation could be short-lived: according to the survey, most hedge fund managers considering domiciling their funds in the EU said they would do so before the implementation of the AIFM Directive in 2013, and fully 69% of them said they were considering doing so by transferring the domicile of their existing funds to the EU.

The research also shows that the UCITS framework, which some respondents said was an effective marketing tool to stem outflows during the financial crisis, has lost some of its appeal amongst hedge fund managers. Indeed, whereas those polled were just as likely to set up UCITS funds as other regulated structures, such as Irish QIFs and Luxembourg SIFs, in the past, 77% of those considering creating an onshore structure in the future now say they would prefer QIFs and SIFs instead.

Undertakings for Collective Investment in Transferable Securities, or UCITS, are formed under a set of EU directives that allow investment funds to distribute throughout the EU on the basis of a single authorization from one member state; UCITS III is the latest iteration of these directives. Despite the focus on EU investors, UCITS III compliant offerings are not limited to EU-located or domiciled hedge fund firms; in fact, firms across all regions have created investment vehicles which are compliant with the UCITS III standards. In some cases, firms are receiving UCITS III approval for existing fund vehicles, while in other cases, firms are launching new products which conform to UCITS III guidelines.

According to a survey earlier this year by Deutsche Bank of 184 investment entities, including wealth managers, family offices, insurers and high-net-worth individuals, among others, the size of the sector is expected to more than double over the next year. However, Tom Brown, KPMG Head of Investment Management for the EMEA Region, said that the market is starting to realize that even though 90% of alternative strategies can be replicated under UCITS, specialized structures such as SIFs and QIFs offer more flexible liquidity and transparency rules for hedge funds.

"UCITS still offers very robust protection for investors, but clearly the wholesale shift into alternative UCITS some had been predicting has not taken place,” he noted.