JOY DUNBAR, EDITOR, ABSOLUTE UCITS
As the alternative UCITS universe matures, it has increasingly become an embedded feature of the alternative investment landscape. At the same time, institutional and retail investors are facing an evolving set of challenges and are finding themselves caught between a rock and a hard place.
Stagnant economies, European sovereign debt crises and uncertainty over the future of the euro have created a storm cloud that looms over the heads of investors and the asset management industry.
The number of new fund launches has slumped to new lows as asset managers cancel or delay alternative UCITS new strategies. In 2012, only 62 alternative UCITS-compliant strategies were unveiled, raising assets of $1.7 billion. This contrasts sharply with 2010, a peak year during which 129 funds raised $9.5 billion of new alternative UCITS assets.
Governmental and central bank intervention in the key economies has come to characterise the global economic landscape. In the UK, the authorities have pumped enormous volumes of money into the economy with a policy of quantitative easing. In the Eurozone, as well, the European Central Bank has pursued a number of policy measures to do ‘whatever it takes’ to save the euro, including the implementation of long-term refinancing operations and the introduction of the Outright Monetary Transactions (OMT) initiative last year.
These measures have enabled financial markets to avoid a major financial crash and prevented a disastrous systemic banking failure. To some degree, confidence has returned to the economy and, albeit weakly, to end-investors.
Widespread monetary intervention is symptomatic of the challenging macro-economic environment in which the long time period of constructing classical investment portfolios – comprising equities, gilts and cash – is well and truly over.
Investors are hunting for income, yield and alpha while they face the problem of dealing with the consequences of inflation eating into their savings – especially if they choose to do nothing. Moreover, the hunt takes on a greater urgency during a period of low interest rates and the looming threat from the Bank of England’s monetary policy committee, which is considering the adoption of negative interest rates in an attempt to force banks to increase their lending. This policy is already in place in countries such as Switzerland, Sweden and Denmark, which have employed this strategy in the last few years.
Since the current investment environment compels investors to take some degree of risk in order to generate returns, diversifying their investments has emerged as a key aspect in their drive to achieve a better total return.
While investors will continue to diversify away from long/short equity strategies that are perceived by some players to be expensive beta plays, there are nevertheless some notable exceptions in the long/short space.
Niche and nimble equity UCITS-compliant hedge funds with limited capacity, such as Majedie Asset Management Tortoise Fund, Prusik Asian Equity Income Fund and CF Odey UK Absolute Return Fund, are continuing to flourish. All these funds have a strong reputation for achieving alpha.
Although investors are showing signs of returning to equity markets, it is not clear whether long/short equity UCITS fund will benefit. But areas like mixed arbitrage and multi-strategy, global tactical asset allocation and other diversified strategies are set to attract greater asset flows.
The increase in the number of multi-asset funds is particularly a response to investor demands for diversifying away from traditional investing; many of these portfolios employ alternative UCITS along with other asset classes. Also, hedge fund managers use alternative UCITS funds as either a cash management or liquidity tool.
Even though equity markets were largely positive last year, the need for investors to achieve downward protection while generating alpha is increasingly at the forefront of their decision making.
Despite the volatile environment, the Absolute UCITS Single Manager Composite Index showed a return of 4% in 2012. Although this result ought to encourage further growth in the sector, performance still needs to improve for investors to increase their allocation to alternative UCITS.
For institutional and retail investors, the uncertain environment means that assets in the alternative UCITS sector are stable.
At December 2012, there were a total of 480 UCITS-compliant alternative investment funds in the Absolute UCITS database, with $147 billion of assets under management.
At the same point at the end of 2011, the sector had $113 billion in assets under management with 479 funds. However, excluding the $34.3 billion Standard Life Investments’ Global Absolute Returns Strategies portfolio, the industry had grown from $93 billion at the end of 2011 to $113 billion by the end of last year.
GROWTH OUTSIDE THE EUROPEAN UNION
Fund managers based in the US, the largest hedge fund industry in the world, continue to launch UCITS-compliant funds, providing their strategy is compatible with the framework. Most US hedge fund managers tend to unveil their UCITS-compliant strategies in partnership with a European-based platform.
A recent trend whereby niche alpha generators are teaming up with larger asset managers to leverage their respective areas of expertise continues to gather steam. For example, GAM has recently purchased a 30% stake in the Connecticut-based, macro specialist alternatives manager, QFS Asset Management. Now that the partnership has been formally agreed, a new alternative UCITS strategy will be launched within the GAM Star range. QFS also has a currency portfolio on the MLIS (Bank of America Merrill Lynch) platform.
One of the main advantages offered by the UCITS Directive is the cross-border passport facility, which attracts fund managers as well as investors from outside the EU. Swiss private banks, for instance, have embraced the framework on behalf of their high-net-worth investors.
The passport concept has also attracted widespread interest throughout the fragmented Asian asset management industry and, with the opening up of mainland China, the alternative UCITS sector may well prove capable of capturing new sources of investor capital.
THE FUTURE: PRODUCT INNOVATION?
In developed countries, where economic growth has been low by historical standards, the alternative asset management industry is responding to changing social, demographic and economic patterns.
According to the UCITS VI consultation, which was published in 2012, the UCITS Directive could potentially expand its brief in the future by encompassing less liquid strategies such as property, infrastructure, and loans – as well as direct investments in commodities.
Currently, alternative UCITS-compliant strategies often involve complex investment techniques which would not be feasible without the use of derivative instruments since this ensures that they retain their liquidity requirements.
The response by the European Fund and Asset Management Association (EFAMA) to the European Commission’s consultation noted: “Despite the complexity lying behind individual techniques, these products have been designed with a view to answering a clear demand from retail investors, often with the aim of reducing volatility and smoothing investor’s returns, leading to reduced investment risks.”
In addition, the association points out that if strategies were regulated away from the UCITS framework, retail investors would seek other less regulated products.
EFAMA has also recommended that either a new name or a brand be incorporated into the UCITS Directive for retail funds that will make a distinction for long-term investments.
Meanwhile, a number of additional regulatory changes to the European asset management industry have been implemented. These include the UCITS V consultation, which brings the UCITS Directive into line with the Alternative Investment Fund Managers Directive (AIFMD).