fund of hedge funds distributors survey 2010

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UCITS FoHF Distributors Survey

February‐March 2010

ABSTRACT

This paper summarizes the results of a survey conducted among 59 Fund Distributors. The survey confirms that there is significant demand for UCITS Hedge Funds and UCITS Funds of Hedge Funds. Despite the fact that distributors expect UCITS Hedge Fund products to underperform their equivalent offshore peers, they consider the distribution potential of UCITS as substantially more important. Distributors have clear preferences in terms of fund domicile and investment approaches. The complete report provides for an overview of the key characteristics a UCITS fund of hedge funds should have, to be successfully distributed. .

ABOUT KDK ASSET MANAGEMENT

KDK Asset Management Ltd is a FSA regulated investment management company focused on delivering innovative and superior investment solutions. KDK works in partnership with hedge fund managers and fund of hedge fund managers, providing assistance in the structuring and development of a UCITS offering. For more Information about our services, please contact: Philippe Keime Henrik de Koning Tel: +44 207 127 4672 Tel: +41 22 575 4617 Mob: +44 77 94 78 37 97 Mob: +41 7978 42669 Philippe.keime@kdk‐am.com henrik.de‐koning@kdk‐am.com

IMPORTANT INFORMATION: This report is provided without guarantee of any kind about the accuracy, completeness or reliability of the information contained herein. No written or oral information provided by KDK Asset Management shall be interpreted as increasing the scope of this warranty. The suitability of the content for any use remains the responsibility of the reader.

Summary Report

KdK UCITS FoHF Distributors Survey – Q1 2010 2

Introduction The market has recently been flooded by a great number of UCITS regulated funds managed by Hedge Fund managers. Top tier houses such as Brevan Howard, MAN Group or GLG Partners have already launched several of such vehicles and are gathering significant assets. These so‐called ‘NewCITS’ have become one of the key topics in the hedge fund industry. UCITS hedge funds are said to manage an estimated USD 35 billion and more than 200 of these funds have debuted in the last 18‐24 months according to Hedge Fund Research. We even saw the emergence of specialized “UCITS Hedge Fund” Indices: 3 of such index‐families were launched in the first quarter of 2010. Many of the funds of hedge funds we are talking to are also widely considering UCITS as a potential instrument to regain assets from private banking clients and high net worth individuals who have not returned to alternative investments yet. We are expecting the UCITS funds of hedge funds market to take off in the near future. In order to get a better understanding of the expectations of investors, we surveyed a number of distributors in Europe and in Asia, including private banks, retail banks, family offices, insurance companies and fund distributors/supermarkets.

Methodology We sent a detailed questionnaire to the people/teams in charge of the selection of (third party) funds at distributing companies located in different jurisdictions. These questionnaires have been completed in February 2010 by a total of 59 respondents representing fund distribution companies located in the following jurisdictions:

Results have been computed at the beginning of March 2010 and are summarized in the present document.

Objective In December 2009, we conducted a survey among 30 of the largest Fund of Hedge Fund managers. Among its conclusions, it showed that most of them intend to enter the UCITS space over the next year. Despite the fact that the fund of hedge fund providers generally expected UCITS hedge funds to underperform their equivalent offshore funds, and that they consider the current investment UCITS Hedge fund universe as being too narrow, the “fund of UCITS” appeared to be the preferred way to structure such offering for a UCITS investor base. The objective of this new survey is to get a better understanding of the drivers in the UCITS Fund of hedge funds market. We sought the distributor’s opinion on the key features of such products in order to derive the optimal product characteristics.

• The first section provides for some background about the respondents and the nature of their demand for UCITS funds of hedge funds.

Asia; 2 Benelux; 5

France; 6

Germany; 8

Italy; 4

Scandinavia; 3

Spain; 6

Switzerland; 18

United Kingdom;

7


• The second section deals with their perception of the market and the benefits of UCITS as compared to other vehicles.

• The third section reviews the key features a UCITS fund of hedge funds should have to be successfully distributed.

This report has been designed to support those fund managers who are considering the launch and the distribution of a UCITS fund of hedge fund: the complete report highlights the preferences of the different groups of distributors in terms of investment objective and investment policy. It also provides for valuable insight with regard to fund domicile, fee structure and subscription/redemption terms. The Fund of Hedge Funds manager Survey (the December Survey) can be downloaded from the company web site: http://www.kdk‐am.com The complete report of the UCITS Fund of Hedge Fund Distributors Survey is available upon request: survey@kdk‐am.com


Part I: Information about the Survey Participants: This section provides for some background about the participants of the survey. A total of 59 institutions completed the questionnaire. In our December fund of hedge fund managers survey,

• 75% of the respondents said they had demand from retail networks and fund platforms/fund supermarkets. • 68% and 61% claimed to have had demand respectively from High Net‐Worth Individuals and family offices. • Only 43% said they had demand from institutional investors.

Our sample is therefore balanced towards the channels serving the high net‐worth individuals, which are widely seen as the ‘natural’ target for funds of hedge funds:

Identify the business category that best suits your company?

Respondents : 59 Skipped Question : 0

In order to take country specifics into account, we asked the respondents for the country of domicile of their clients:

In which of these countries are your clients mainly located?

Respondents : 59

Skipped Question : 1

In terms of size, the aggregate assets under management (or distributed AUM) is well in excess of the trillion EURO figure. It is also worthwhile to point out that the respondents are equally distributed in terms of significance of distribution. The largest private banking networks participated to this survey as well as a certain number of small specialized UCITS/Hedge Fund distribution boutiques.

Private Banking 47%

Fund distributor/

Fund Supermarket

22%

Retail Banking 12%

Insurance Company

7%

Family Office / Private Investor

12%

Core Business Of Respondent

Germany 19%

France 8%

United Kingdom

11%

Italy 6% Spain

10% Scandinavia 5%

BeNeLux 12%

Other EU 1%

Switzerland 23%

Other non‐EU 5%

Location of end client


Size of your asset under management/ distribution?


The combined annual distribution of funds of the respondents is somewhere between 50 and 100 billion EURO, which gives us confidence that this survey is representative of the general trends in respect of this business segment:

Average annual Turnover of assets under management/distribution?


The respondents are familiar with UCITS...

% your assets being UCITS?

Respondents : 59


< 1 Bn 20%

1Bn to 5Bn 20%

5Bn to 25Bn 22%

25Bn to 100Bn 20%

> 100Bn 18%

Level of Assets Under management / Administration

< 250m 31%

250m to 1Bn 29%

1Bn to 5Bn5 27%

> 5Bn 13%

Annual Turnover of AUM

< 50% 39%

50% to 75% 31%

75% to 100% 30%

Proportion of UCITS


... and Alternative Investment Strategies:

% of your assets qualifying as Alternative Investment Strategies (including structured products)?


An interesting finding is that these distributors have their assets more or equally split between single managers and funds of funds.

Is this allocation made through single managers or funds of funds?


< 10% 40%

10% to 25% 39%

25% to 50% 9%

> 50% 12%

Proportion of AIS

Single Managers

51%

Funds of Funds 49%

Type of AIS Holding (average)


Expectations: We asked the survey participants some broad questions with regard to their expectations of future development of their business:

In 2010, do you expect the proportion of alternative investments to?


A vast majority of the respondents expect the allocation to alternative investment strategies to increase in 2010. This is consistent with the results published recently in Deutsche Bank's annual alternative investment survey. Investors are planning significant allocations to hedge funds this year. In terms of potential, both single strategies and funds of hedge funds are clearly in demand:

Have you had demand for UCITS of Hedge Funds? Single strategies Respondents : 59


Have you had demand for UCITS of Hedge Funds? Funds of Hedge Funds Respondents : 59


The potential for UCITS funds of hedge funds seems to be slightly less important than the demand for single strategies. Some respondents told us that, for their part, this is mainly due to the fact that investors are not convinced that multi‐manager funds of good quality can be delivered because of the too narrow investment universe. It is generally accepted that some hedge fund strategies, among which some with the highest potential returns (such as distressed securities or convertible arbitrage), are difficult to transpose in a UCITS.

65.52%

3.45%

31.03%

Increase

Decrease

Remain Stable

Expected Future proportion of AIS

72.88%

20.34%

6.78%

Single strategy ‐ YES

Single strategy ‐ NO

Single strategy ‐ DON'T KNOW

Do you have demand for UCITS HF

67.24%

25.86%

6.90%

Fund of Funds ‐ YES

Fund of Funds ‐ NO

Fund of Funds ‐ DON'T KNOW

Do you have demand for UCITS HF


We generally agree with the concerns of these distributors who assume that a fund of hedge fund manager who is restricted to only 150‐200 funds (mainly Long/Short Equities or credit, or directional global macro strategies) is likely to have difficulties to generate an attractive risk/return profile. As we will see further below, UCITS fund of hedge fund managers can theoretically substantially enlarge their investment universe by investing in other vehicles. These vehicles are in many instances also accessible to end‐investors. We asked the survey participants for their opinion:

Is such demand specific for UCITS or can it be satisfied with other vehicles? Respondents : 59


A majority (58% of the respondents) considers UCITS as the only viable solution. Non‐UCITS Retail Investment Schemes in the UK, Swiss funds in Switzerland, certificates in Germany or other listed/closed‐end funds have often proven powerful instruments to distribute funds of hedge funds products to a wider public. The potential of such vehicles is a function of timing (closed‐end funds are likely to be less attractive in a period where many of such instruments are trading at a substantial discount to NAV as it was the case last year) and of target jurisdiction. Indeed, if we break down the responses of this question in function of the domicile of the respondent’s clients, we get the following picture:

No 58%

closed‐end fund 9%

Domestic Fund (non‐UCITS) 16%

Securitised Product 14%

Other 3%

Yes

Can such demand be satisfied with other Investment Vehicles

No 50%




Yes

Can such demand be satisfied with other Vehicles (UK + Scandinavia)

No 65%




Other 3%

Yes

Can such demand be satisfied with other Vehicles (Switzerland)

No 75%


Domestic Fund (non‐UCITS) 6% Securitised

Product 6%

Yes

Can such demand be satisfied with other Vehicles (Italy + Spain)

No 56%




Other 4%

Yes

Can such demand be satisfied with other Vehicles (France+Germany+Benelux)


Highlights of Section I • We are in presence of strong demand for alternative investments. Only 3.5% of

respondents will reduce their allocation in 2010. • The Demand is substantial both for UCITS single strategies and UCITS Funds of

Hedge funds. • Almost 60% of this demand can be exclusively satisfied through a UCITS vehicle.


Part II: Hedge funds and UCITS This section details the assessment the respondent makes of this market.

How many UCITS Funds of Hedge Funds do you think are already on the market?


For our part, we have identified 21 UCITS, which performance depicts the combined performances of different alternative asset manager (multimanager). The above result is fairly consistent with the list of multi‐manager UCITS we have identified:

Name Domicile Fund

Inception Date

AUM in EUR Mio (KdK Estimate)

Structure

1 Credit Suisse Solutions Lux ‐ CS Tremont AllHedge Index LU 19/03/2008 141.6 Index Fund

2 db x‐trackers ‐ db Hedge Fund ETF LU 11/03/2009 607.2 Index Fund

3 Lyxor Active Edge Fund LU 07/04/2009 63.5 Index Fund

4 Man Umbrella SICAV ‐ Man Multi Manager LU 18/08/2008 78 Index Fund

5 Erste Sparinvest – Salus Alpha Event Driven AT 29/02/2008 14.7 Index Fund

6 Erste Sparinvest ‐ Salus Alpha Equity Hedged AT 24/09/2007 14.8 Index Fund

7 Erste Sparinvest ‐ Salus Alpha Managed Futures AT 29/02/2008 13.7 Index Fund

8 Erste Sparinvest ‐ Salus Alpha Multi Style AT 01/04/2009 7.3 Index Fund

9 OCEANO ‐ 3A Dynamic Ucits Fund USD LU 15/09/2009 13.2 Fund of UCITS

10 Collins Stewart Alternative Strategies Fund IE 28/10/2009 14.5 Fund of UCITS

11 Kairos International Sicav ‐ Long Short LU 04/05/2009 153 Fund of UCITS

12 Traditional Funds Plc – Thames River Absolute Return Fund IE 13/01/2010 36.5 Fund of UCITS

13 Legg Mason Global Funds Plc ‐ Permal Global Absolute Fund IE 24/09/2009 33.2 Fund of UCITS

14 HSBC UCITS AdvantEdge plc ‐ HSBC UCITS AdvantEdge Fund IE 14/10/2009 62.5 Fund of UCITS

15 Barclays Multi Alfa FI ES 05/06/2003 83.3 Fund of UCITS

16 Barclays Multifondo Alternativo FI ES 08/11/1999 14.1 Fund of UCITS

17 IFSL Blacksquare Capital Fund ‐ Multi‐Manager Absolute Return Fund GB 01/02/2010 1.2 Fund of UCITS

18 Foncaixa 134 Gestion Dinamica V3 FI ES 27/09/2005 13.5 Fund of UCITS

19 Gartmore Investment Fund Series IV ‐ Gartmore MultiManager Absolute Return

Fund GB 04/10/2004 55.4 Fund of UCITS

20 Amundi Funds ‐ Multimanagers Long/Short Equity LU 18/02/2010 1 Fund of UCITS

21 SEB Multi‐Manager Currency Fund LU 31/03/2009 7.9 Fund of managed

accounts Data Source: KDK FoHF Monthly Snapshot as of March 15 + Bloomberg and Management Companies

It is interesting to note that from these 21 funds, a significant proportion (9) are so‐called „Index constructions“, i.e. funds that get exposed to a fund of hedge fund strategy structured as a financial index through a total return swap. Quite interestingly, most of the funds based on an index structure have been

< 10 14%

10 to 20 27%

20 to 30 25%

> 30 18%

don't know 16%

Perception: Number of existing UCITS FoHF


created more than a year ago and it seems that this approach is no longer popular. This topic will be explored in more depth in section III of this report.

How many UCITS Hedge Funds (single strategy) do you think have already been launched by Hedge Fund managers?


It is difficult to properly assess the size of this market. There is no such thing as a classification of UCITS which could help to isolate hedge fund strategies from traditional investment strategies. News articles and press releases on the topic put figures forward ranging from 100 to 350 UCITS Hedge Funds already launched (in excess of 500 if one takes Absolute Return Bond funds and 130/30 funds onto account). We believe there are about 150 of such funds open for investment. Performance: UCITS rules have been designed firstly for long only investments. A number of instruments or techniques used by alternative investment managers are not compatible with the UCITS restrictions. Applying UCITS’ Investment rules to alternative strategies may have a significant impact on their performances if done without using adapted investment solutions. This view seems to be shared by a majority of the survey participants.

How do you expect the performance of a UCITS Hedge Fund (single manager) to compare to its equivalent offshore fund?


In fact, respondents believe that the implementation of the same investment strategy in a UCITS impacts the performance negatively, reducing the potential for return as compared to the same strategy delivered in an offshore fund. The order of magnitude of this difference is even expected to be significant (in excess of 3% p.a.) by approximately 10% of the survey participants. This underperformance is widely expected because, as compared to their traditional framework, managers are facing a certain number of investment and implementation challenges, such as, but not limited to, stringent diversification requirements, prohibition on direct investment in certain assets such as commodities and on physical shorting, limited leverage, and strict liquidity requirements. Some of these challenges can be overcome with the use of derivative instruments: provided certain conditions are met. Short positions, leverage and even exposure to ineligible assets will be possible through

< 50 7%

50 to 100 37%

100 to 200 25%

> 200 17%

don't know 14%

Perception: Number of existing UCITS HF (Newcits)

significantly lower (>3%)

10%

lower 75%

identical 10%

not comparable 5%

Expected Performance of a UCITS HF as compared to equivalent Offshore HF


the use of financial derivative instruments. This, however, will come at a price and will impact the performance of the UCITS Hedge fund. UCITS hedge funds constitute a very valid investment proposition in themselves. Distributors, however, are aware that relative to their offshore counterparts, their performance will almost certainly be lower due to additional investment restrictions and higher transaction costs. In terms of fund fees, only a quarter of the respondents are expecting lower total expense ratios:

How do you expect the Total Expense Ratio (TER) of UCITS Hedge Funds (single manager) to be as compared to their equivalent offshore funds?


We find this result quite surprising. We expected another outcome as we assumed that distributors would have expected fund promoters to take into account,

1. that UCITS Hedge Funds are likely to have a lower performance than their offshore counterparts, and

2. that UCITS Hedge Funds, which have mostly been launched after the crisis, are by definition at their high water mark level, which provides for higher profit perspectives than the average offshore funds.

Actually, as we were told by some respondents, it is generally accepted that managing a UCITS is more cumbersome than managing an offshore fund, and that since it has more frequent liquidity, a premium has to be paid at the investor level. Such premium should also protect the hedge fund managers from a ‘cannibalization’ of their offshore offering. Hedge Fund UCITS are thus probably going to be less attractive or have a worse risk/return ratio than a traditional (offshore) hedge fund. But let’s keep in mind that UCITS offer lots of advantages in terms of distribution.

Lower 25%

Identical 22%

Higher 53%

Expected TER as compared to equivalent Offshore Fund


In our December fund of hedge fund survey, it appeared clear that the fund of hedge funds industry believed the biggest selling points of UCITS is improved liquidity terms closely followed by more transparency and regulatory oversight. We asked the UCITS distributors the same question and we found similar results:

Where do you see the value added of UCITS as compared to offshore funds?


The above table has been computed on the basis of all the responses given, making the average of 0 for „no benefit“ (or N/A), 50% for „marginal benefit“, and 100% for „strong benefit“

• Lower due diligence costs are seen as a marginal advantage. We agree with this. Indeed UCITS protects only partially against fraud and when it comes to the assessment as to whether the manager or the different service providers have the experience, the capabilities and the adequate set‐up to fulfill their tasks, the client still has to perform his own analysis.

• Risk Management Framework: The UCITS requirement for the implementation of a risk management process is seen as mildly positive. Actually, the fact that a hedge Fund manager will typically have to perform more complex transactions than in an offshore fund fully justifies some additional safeguards... We struggle to be convinced by the (very) broad rules outlined in the Directives but if one assumes that some additional risk measurement cannot harm, we are on the same line as the respondents.

• Transparency / Reporting: is seen as a significant advantage of UCITS over offshore funds. Mandatory reporting, however, is limited to the production and filing with the regulator of (audited) annual accounts and (unaudited) semi‐annual accounts. In terms of transparency (i.e. the type of information disclosed), we believe the norm for a UCITS is not really more valuable to investors than what the average offshore hedge fund provides.

• Regulatory oversight: A true advantage of UCITS. Assets are to be held in a segregated account and placed under the responsibility of the custodian.

• Liquidity: a UCITS must provide liquidity at least twice a month. It is also worthwhile pointing out that it is more difficult to gate a UCITS (although not impossible, as opposed to is widely assumed) or to organize side‐pockets. Therefore, one can assume that managers should be more careful about liquidity mismatches. Liquidity requirements will be further detailed in section 3 of the report.

UCITS and Managed Accounts are usually named as the responses the industry came up with to address the type of issues investors faced in the 2008 Hedge Fund Crisis... We asked the distributors whether they see one of these solutions as a superior or more appropriate response considering their own investors’ concerns:

90.00%

67.27%

84.55%

84.26%

50.00%

Better Liquidity Terms

Risk management framework

Regulatory Oversight

Transparency/Reporting

Lower Due diligence costs

Value Added of UCITS as compared to Offshore Funds


Do you consider UCITS to better address current investor concerns than managed accounts?

Respondents : 59


The result is a bit surprising at first sight: Don’t Managed Accounts also offer transparency and liquidity as their main benefit? If we believe recently published research, the renewed interest in managed accounts is mainly a consequence of recent negative liquidity experiences such as gates and side pockets, as well as the impact of some high profile fraud cases. Investors now believe they are better off investing in a portfolio that they control themselves rather than being co‐mingled with other investors and thus vulnerable to their behavior... On top of liquidity concerns, requirements for more transparency and better risk management have also contributed to this shift towards a managed account structure. Investors we speak to, sometimes also quote the ability to impose investment guidelines as a significant advantage of this approach. In short, managed accounts constitute a valuable opportunity to improve (1) liquidity terms, (2) mitigate operational and fraud risk and (3) get a better visibility over the risk exposure of an investment. We believe that the reason why a majority of the respondents prefer UCITS over a managed account solution is practical: (Real) managed accounts are not accessible to smaller investors and many can’t cope with the operational burden nor are they sophisticated enough to deal with the information he will have access to. We are of the view that the principal advantage of a managed account is the isolation of the investment management role from all other activities related to the management of the investment (administration, risk monitoring, reporting, etc), in order to increase transparency and control. This is also a given with UCITS. This result can probably also be explained by the fact that the large investors (pension funds and funds of funds) are expected to be the main users of a (individual) managed account approach, whereas UCITS is a more suitable solution for distributors.

yes 50%

No 19%

No opinion 9%

Not comparable propositions

22%

Do UCITS better address investors' concerns than Managed Accounts


Distribution potential: When asked whether UCITS present more distribution potential than offshore funds, the response is very clear: 90% of the respondents (and even 100% in jurisdictions like France or Germany) believe that the UCITS wrapper adds potential:

How would you consider the distribution potential to your client base for a UCITS hedge Fund compares to its equivalent offshore fund?


Highlights of Section II • 85% of participants expect UCITS Hedge Funds to perform less than equivalent

offshore funds but 90% of the respondents consider they have more distribution potential

• UCITS is seen as a more adequate vehicle to eventually regain investors who

redeemed hedge funds during the crisis • UCITS’ main benefits are liquidity terms, followed by transparency and regulatory

oversight.

Lower 2% Identical

8%

Higher 56%

Significantly Higher 34%

Distribution potential for UCITS HF as compared to offshore HF


Part III: Fund of Hedge Funds Product Requirements There is a widespread belief that a hedge fund manager only needs to launch a UCITS to see dozens of pension funds, insurance companies and private banks pour money into it. Needless to say that this is largely overstated… More than an asset management tool, UCITS is a distribution wrapper. The main challenge for hedge fund and fund of hedge funds managers lies in the fact that UCITS asset gathering is a fundamentally different exercise than raising ‘offshore’ assets. In order to fully exploit the UCITS potential, a manager will need to understand what the distributors want, that is: setting up the fund in the right jurisdiction, providing for adequate liquidity, charging an adequate level of fees, rebating enough trailer fees, etc. This section has been designed for to support fund of hedge fund managers who are considering the launch and the distribution of UCITS funds of hedge funds. It is available upon request: survey@kdk‐am.com

Disclaimer Copyright © 2010 by KdK Asset Management Ltd., 11 Albert Bridge Road, London SW11 4PX, United Kingdom All rights reserved. Reproduction or retransmission in whole or in part is prohibited except by permission. All information contained in this report is based on information obtained from third party fund distributors and other sources which KdK believes to be reliable. KdK does not cross‐check or verify the truth or accuracy of any such information. Consequently, KdK provides this report without guarantee of any kind regarding its contents. This document is for information purposes only and should not be construed as investment advice or an offer to sell (nor the solicitation of an offer to buy) any of the securities it refers to. Neither this document nor the securities referred to herein have been registered or approved by any regulatory authority of any country or jurisdiction. This material is confidential and intended solely for the information of the person to whom it has been delivered and may not be distributed in any jurisdiction where such distribution would constitute a violation of applicable law or regulation. While this document represents the author’s understanding at the time it was prepared, no representation or warranty, either expressed or implied, is provided in relation to the accuracy, completeness or reliability of the information contained herein, nor it is intended to be a complete statement or summary of the securities markets or developments referred to in the document. It should not be regarded by recipients as a substitute for the exercise of their own judgment. Investing in securities and other financial products entails certain risks, including the possible loss of the entire amount invested. Certain investments in particular, including those involving structured products, futures, options and other derivatives, are complex, may entail substantial risk and are not suitable for all investors. The price and value of, and income produced by, securities and other financial products may fluctuate and may be adversely impacted by exchange rates, interest rates or other factors. Information available on such securities may be limited. The securities described herein may not be eligible for sale in all jurisdictions or to certain categories of investors. You should obtain advice from your own tax, financial, legal and accounting advisers to the extent that you deem necessary and only make investment decisions on the basis of your objectives, experience and resources. Past performance is not necessarily indicative of future results. Unless specifically stated otherwise, all price information is indicative only. No liability whatsoever is accepted for any loss (whether direct, indirect or consequential) that may arise from any use of the information contained in or derived from this document. KDK does not provide tax advice and nothing contained herein is intended to be, or should be construed as a, tax advice. Recipients of this report should seek tax advice based on the recipient’s own particular circumstances from an independent tax adviser.

fund of hedge funds distributors survey 2010

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