
President Anastasiades talks Investment at the Cyprus-China Business Forum
President Nicos Anastasiades emphasised the wide array of both business and investment opportunities that...
The European hedge fund industry has grown since the financial crisis, with assets reaching a new high of $640 billion. 1 Most of this growth, however, has come from the absolute return UCITS sector, a subset of the €7.98 trillion European mutual fund industry. 2 & 3 Since 2009, compound annual growth in UCITS absolute return funds has been 47% compared to only 5% for offshore hedge funds.
The growth is partly the result of hedge fund managers replicating their existing hedge fund strategies in a UCITS format in order to tap into a new investor base hungry for absolute return strategies offered as liquid funds with strong governance.
Hedge fund managers that want to tap the European pool of capital now need to consider two legislative frameworks. These are the newly introduced AIFMD for alternative funds drafted in response to the financial crisis and the more established UCITS Directive for mutual funds. The two regulations share many similarities by design but differ in terms of investment guidelines and eligible investors.
AIFMD
UCITS
Given that both hedge fund managers and investors have embraced the idea of offering absolute return products in a UCITS format, the question facing market participants is whether the introduction of AIFMD will have the same positive impact on the industry. The answer to this question will help managers determine their strategic approach to raising assets in Europe.
In order to make this determination, managers should:
UCITS funds: Funds domiciled in Europe and managed according to the terms of the UCITS Directive
AIFMD funds: Funds domiciled in Europe and subject to the terms of the AIFMD
Offshore funds: Funds domiciled in a non-European offshore jurisdiction, usually Cayman Islands, BVI, Bermuda, Jersey or Guernsey
The landscape for hedge funds that are raising capital in Europe has changed considerably since the financial crisis. A once one-dimensional industry now has a wider range of regulatory structures and a broader investor base. The AIFMD and UCITS Directives have a significant influence on the way managers seek to raise assets and the investors that they target.
Asset growth from Europe since the financial crisis has come predominantly from the adoption by managers of the UCITS framework. By using this established regulatory model, managers have been able to diversify their client base to include a large pool of investors accessed through the private-wealth channel.
The introduction of AIFMD has brought the potential for greater transparency and disclosure but does not appear to have taken hold with investors yet. These funds are still purchased predominantly by an investor base already comfortable with offshore hedge funds. However, without the emergence of a trigger for either the creation of AIFMD funds by managers, or a corresponding increase in demand for funds of this type, we expect the adoption of AIFMD by the market to be slow.
By contrast, funds established as UCITS have enjoyed greater momentum in terms of both adoption by managers and raising assets. In our view, specific catalysts emerged following the financial crisis, which encouraged hedge fund managers to establish UCITS funds. At the same time, this supply satisfied a hitherto unmet demand from investors. Furthermore, UCITS was already a well established and broadly recognized brand in its own right.
Given this backdrop, there is much to consider for managers looking to Europe for distribution.
Important differences separate offshore/AIFMD and UCITS funds in terms of the investment guidelines, meaning that not all strategies can be easily replicated into a UCITS wrapper. Managers have various options depending on whether it is possible to create a UCITS or AIFMD fund.
The adoption of AIFMD and UCITS may open up new markets for managers to market their funds. They will need to consider:
Both AIFMD and UCITS rules necessitate additional activities in terms of investment management and compliance, which may require additional personnel and systems resources. These include:
Targeting the European onshore investor base increases complexity for managers. However, many options exist to help managers in structuring and distributing their funds. As a result, managers may consider partnering with certain local providers for services such as:
There is evidence that hedge fund managers have begun to adopt the new regimes. The available data show that European managers have implemented UCITS considerably more readily than AIFMD with, on average, 48% of new funds established in UCITS format and 15% under AIFMD.4
If we distinguish between managers with their headquarters in the U.S. rather than Europe, the conclusion is even more pronounced. U.S. managers have largely ignored the AIFMD regime altogether, preferring offshore structures.
It is also informative to consider which regulatory regime has seen the largest growth in assets. Exhibits 4 and 5 illustrate the cumulative increase in total Assets Under Management (AUM) and AUM per fund for the cumulative 2010–2014 vintages and the fund launches for Europe based managers respectively.
The contrast between assets raised in offshore and UCITS structures is striking compared to assets raised in (now AIFMD-compliant) onshore structures.
1. Source: Eurohedge April 2015
2. Source: EFAMA Quarterly Statistical Review February 2015
3. The U.S. mutual fund market is $16 trillion in size
4. Source: Eurohedge April 2015. Based on number of funds launched 2010 to 2014
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