Understanding UCITs III

“UCITs III removes 90% of the risks associated with investing with a boutique fund manager”. 

“Whilst performance risk remains, UCITs III removes the risk of total capital loss through counter party failure”.

Two comments from panellists at yesterday’s inaugural Absolute UCITs conference summed up the attractions of a UCITs III fund structure for UK investors and UK Investment Advisers.

The UCITs III regulations, soon to be UCITs IV (next month), provide a European wide passport to enable managers to sell their funds to any retail investor in member states, which has also attracted a kite mark like standard in Asia and Latin America.  Importantly they represent the highest level, state of the art investor protection for those looking to invest in alternative investment strategies rather than buy and hold long-only funds.

A quick review of recent history reminds us of the additional risks UK investors face when they invest in small fund managers, single counter party structured products, a UCIS (unregulated fund) or fund domiciled in a ‘regulatory lite’ jurisdiction such as the Cayman Islands, which have dominated UK alternative investing.

• Madoff, has to be the best high profile example for many years of a boutique manager operating with funds domiciled in ‘regulatory lite’ jurisdictions.  This did not affect just those who invested directly but all the fund of fund products whose due diligence failed to raise any alarms and who allocated to the fund.

• Lehman Bros, highlights the risk of a single counterparty to structured products such as the Key Data product range now collapsed and the many hedge funds who used Lehman as their sole prime broker and could not extract their fund’s assets.

The regulators have learnt from these lessons and included in the UCITs III regulations are:

• Limits on counter party concentration
• Limits on gearing and Value at Risk (VaR)
• Rules on liquidity and limits on the ability of managers to ‘gate’ funds preventing investors from redeeming units
• Rules on independent directors of each fund

It was obvious listening to the German and French contingent at the conference that such issues have been front of mind in advisers and investors in these countries for many years. The more conservative Germans have been using the UCITs framework for many years to invest through Luxembourg in offshore funds, with at least as good, if not better, investor protection as compared to an onshore German fund. The term “Anglo Saxon Investor” even came up at one point as a category of investor prepared to play fast and loose with their money in offshore locations without the UCITs framework.  Perhaps we would do well to learn from our European cousins on this. 

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