This year we have seen a marked resurgence of UCITS funds being launched for alternative investment strategies. This is the second wave of ‘newcits’ since the financial crisis. The first wave was a run to liquidity; as the crisis played out investors needed to put their money to work and UCITS funds provided that reassurance of liquidity. This time, in my view, we are seeing a flight to quality; investors feel safe with a known product. In both cases it is arguable whether the UCITS solution fully meets investors’ objectives.
UCITS funds must offer investors a minimum of bi-monthly liquidity and have liquidity monitoring obligations on the underlying portfolio, with the vast majority of funds offering daily and weekly liquidity. These obligations will not completely remove the possibility of suspending NAVs should we ever see another deep liquidity crisis. UCITS funds are well regarded and trusted by investors, and rightly so. However there seems to be a trend for investors to ask for a UCITS product even though the strategy may not always be best suited to the confines of the UCITS wrapper. Numerous established alternative players have launched or re-launched UCITS products this year at the request of investors. But there may be cases where some investment strategies would weather a financial storm better in a SIF under AIFMD. Alternative funds usually offer protracted settlement periods that allow the manager to liquidate the assets in an orderly fashion. Typical UCITS redemption settlement cycles may see the investors suffer the impact of forced asset sales into the market.
Inherently, pure alternative managers are usually pulled into the world of UCITS products at the behest of their investors. For some this is absolutely the right strategic path, but others may be incurring unexpected operational and regulatory risk, attracted by the success stories of UCITS and cross border distribution. A UCITS fund can absolutely be a great option to access European investors with a single product. UCITS products can help managers attract investor capital, but at a cost. As is often the case, this cost becomes justifiable to investors when economies of scale kick in. A small manager may struggle to court the larger established service providers, who are also looking for economies of scale to cover their service costs in a mature and competitive market. A manager may choose the cheaper service provider to try and minimise the impact of the costs and control their TER, but must not forget that the quality of service and technology supporting them will often be directly correlated to the cost. UCITS distribution channels have become automated anonymous interfaces where the manager does not know their end investor. Alternative funds have historically paid a higher premium for outsourced administration services because their products are more tailored to their investors, with whom they are in direct contact.
Both the Investor and the Manager must educate themselves to understand the levels of cost and operational risk based on the strategy, as well as the targeted markets, and the operational and technological infrastructure servicing the fund. Just because the strategy may work in a UCITS fund on paper does not mean it will work in the real world.
Nick Curwen, SS&C GlobeOp (Luxembourg) Sarl
ALFI TASC Member