UCITS III Attracting Hedge Fund Managers

by Robin Pilgrim, LawandTax-News, London

17 September 2009

New interest has been kindled in a European investment fund vehicle, UCITS III - "Undertakings for Collective Investments in Transferable Securities". Hedge funds Man Group and Cheyne Capital are in the process of launching onshore funds in this format following in the wake of Brevan Howard, Marshall Wace, and Kairos Partners.

The attraction of this format is that it has a tried and tested regulatory framework that allows it to be set up and approved in one European jurisdiction and then marketed to retail investors in all other EU countries subject to a simplified registration process. Also, it is convenient for European fund of funds managers to invest in other managers’ funds if they are constituted as UCITS funds, when Europe-wide distribution is the goal. The UCITS III rules allow up to 100% investment in other funds provided that these funds are regulated to a standard equivalent to a UCITS, subject to a maximum of 20% in any one investment.

The investment managers are subjected to regulations restricting investment and borrowing powers. There are other restrictions; for example, no more than 10% of the Net Asset Value may be invested in any single security. However, as the product develops, a much broader range of Financial Derivative Instruments (FDIs) has become permissible and the derivatives can leverage these funds by up to 100%. Under the UCITS III rules, investment managers can be long up to 100% in directly held equity securities and short up to 100% using stock specific derivatives such as contracts for difference (CFDs) or stock specific futures.

The regulatory framework provides a degree of reassurance to investors that fund managers wish to tempt back into the alternative investment markets after the shocks of the economic crisis, and yet they are exempt from the scope of the European Commission's controversial draft Alternative Investment Fund Manager directive. In addition, as far as the UK is concerned, the reduced rate of capital gains tax has worked to the detriment of offshore hedge funds, which do not qualify for capital gains tax treatment in contrast to UCITS onshore funds.

Man Group, the world's biggest listed hedge fund firm with USD43.3bn under management, will launch its second UCITS III fund in October under the title "Man AHL Diversity." It will allow EU private investors access to the AHL alpha investment strategy, trading in almost 90 markets. Cheyne Capital Management, incorporating Altedge Capital, has launched the Cheyne Select Convertibles fund and plans macro and credit fund launches in the near future. AHL Diversity will be a Luxemburg-listed SICAV fund, while the Cheyne Select Convertibles fund is regulated by the Irish Financial Services Regulatory Authority.

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