Newcits E-Book

Filippo Stefanini

• Herausgeber: John Wiley & Sons
• Kategorie: Fachliteratur
• Sprache: Englisch

Seitenzahl: 168

Veröffentlichungsjahr: 2011

Beschreibung

Due to their strong regulatory frameworks, UCITS compliant hedge funds have seen a boom in recent years and are considered by many as the only way out for the hedge fund industry after the crisis. Newcits: Investing in UCITS Compliant Hedge Funds is a one-stop resource for investors who want to get the best out of their UCITS investments. There is a large and increasing range of UCITS compliant funds out there, but despite their tighter regulation and frameworks, investors still need to understand the risks they are undertaking, the structures of the funds and their differences and similarities to mutual funds and hedge funds. The book begins with an assessment of the financial crisis from the perspective of hedge funds and funds of hedge funds. Then it introduces the UCITS framework and shows how these strategies present a valuable and attractive alternative to offshore hedge funds and funds of hedge funds. The regulatory framework is described in depth, as are the different business models used by asset managers. Finally it looks at current hedge fund strategies such as long/short equity or global macro, and at how these can be integrated into the framework. The book also describes in detail the Newcits industry, discussing the performances, the fee structure, the liquidity and the key theme of "replicability", studying the tracking error volatility of the Newcits funds in comparison with their offshore versions. A discussion of the effectiveness of the regulation and its potential developments concludes the book.

Leseprobe

Contents

Cover

Half Title page

Title page

Copyright page

Preface

Introduction: The Crisis of 2008 and the Way Out

Chapter 1: From UCITS Directive to UCITS III Provisions

1.1 Product Directive

1.2 Management Company Directive

1.3 Additional Regulatory Limits Imposed by UCITS III

1.4 The Next Step: Ucits IV Directive and New Provisions by EU

1.5 Simplification of the Notification Procedure

1.6 Replacement of the Simplified Prospectus with the Key Investor Document

1.7 Management Company Passport

1.8 Master–Feeder Structures

1.9 Mergers Between UCITS

1.10 New EU Directive on Alternative Investments

Chapter 2: Business Models for the Production of Newcits and Managed Accounts

Chapter 3: Analysis of the Operational Model of UCITS III Products

3.1 Luxembourg SICAVs

3.2 CSSF 07/308 Circular: Guidelines for Luxembourg UCITS

3.3 Swing Pricing

3.4 Depositary Bank, Administrator and Lack of Prime Broker

Chapter 4: Hedge Funds Investment Strategies and Limits Set by UCITS III

4.1 Long/Short Equity

4.2 Relative Value

4.3 Directional Trading

4.4 Event-Driven (or Special Situation)

4.5 Other Strategies

4.6 Limits Imposed by UCITS III

4.7 “Synthetic” Short Selling and Contracts for Difference

4.8 Synthetic Newcits

Chapter 5: The Early Stages of the Newcits Industry

5.1 Description of Sample

5.2 Implemented Strategies

5.3 Fee Structure

5.4 Performance Analysis

5.5 Tracking Error and Tracking Error Volatility

5.6 Multivariate Regression Analysis on Panel Data

5.7 Exposure to Risk Factors for Each Strategy

5.8 Contribution by Factor to the Historical Returns

5.9 Liquidity Comparison

5.10 Performance Contribution Analysis at Industry Level

Conclusions

References

Acronyms

Index

Newcits – Investing in UCITS Compliant Hedge Funds

For other titles in the Wiley Finance series please see www.wiley.com/finance

Originally published in Italian I fondi Newcits.Copyright © 2010 by Il Sole 24 ORE S.p.A.

This English language edition translated by Filippo Stefanini and published byJohn Wiley & Sons, Ltd

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Library of Congress Cataloging-in-Publication Data

Derossi, Tommaso.[Fondi Newcits. English]Newcits : investing in UCITS compliant hedge funds / Tommaso Derossi, Michele Meoli, Silvio Vismara ; edited by Filippo Stefanini.p. cm.“Originally published in Italian I fondi Newcits, c2010 by Il Sole 24 ORE S.p.A.”“This English language edition translated by Filippo Stefanini.”Includes bibliographical references and index.ISBN 978-0-470-97627-21. Hedge funds–European Union countries. 2. Investments–European Union countries.I. Meoli, Michele. II. Vismara, Silvio. III. Stefanini, Filippo. IV. Title.HG5424.5.D47 2011332.64’ 524094–dc22

2010044301

A catalogue record for this book is available from the British Library.

ISBN 978-0-470-97627-2 (paperback), ISBN 978-0-470-97949-5 (ebk),ISBN 978-1-119-99197-7 (ebk), ISBN 978-1-119-99198-4 (ebk)

Preface

This book, taking the analysis of the causes of negative investor perceptions of hedge funds as a starting point, elaborates the constraints and the opportunities offered by European directives about UCITS1. These allow us to face, and go beyond, the investors’ distrust, with the ambition of representing a useful educational tool for the players in such a complex sector. In fact, in Europe, the most important answer to the crisis has been to exploit the principles contained in the UCITS III directive. These principles have guaranteed the solidity of the mutual fund industry during the crisis and have permitted the development of funds managed with investment techniques similar to those used by hedge funds. The UCITS III regulation, with the extension of such principles even to hedge funds, increases the investors’ protection and opens to retail investors a world so far perceived as ‘elitist’, and confined exclusively to high-net-worth individuals or institutional clients. This is of great importance if we consider the wide and growing need of both financial advisory and absolute return products.

A European regulatory framework for alternative asset managers is rapidly evolving. The uncertainty surrounding the directive on Alternative Investment Fund Managers proposed by the European Commission, and the arrival in 2011 of the UCITS IV directive, are strong incentives towards the convergence of an alternative and the traditional form of asset management. This pushes alternative asset managers to implement some investment strategies into vehicles that are UCITS III compliant. Hedge products that follow the prescriptions of the UCITS III regulation are frequently labelled ‘Newcits’. These Newcits funds represent an interesting opportunity to access, with safety, the excellent competencies in the absolute return of those money managers that have been able to navigate the stormy seas of the crisis. According to a recent survey by Hedge Funds Intelligence on 650 investment houses, more than half of the European asset managers have already launched, or are shortly intending to launch, an onshore version of their strategies. In the same direction, another market analysis performed by KDK Asset Management found that about 80% of asset managers have declared their intention to consider a UCITS III compliant version of their hedge funds. The brand UCITS III is therefore perceived positively, despite the fact that some UCITS III funds invested in products linked to Madoff.

We wish to emphasize that if, from one viewpoint, the push of UCITS III compliant hedge funds determines a greater level of protection from operational risks; from another viewpoint there could be an inducement for managers of funds of hedge funds to limit the due diligence activities on money managers and counterparties, compromising the adequacy and the efficacy of the investments. In order to avoid this improper approach, this book can represent a useful support tool. I thank Filippo Stefanini, who has described an exhaustive framework of these new trends that will help all those concerned to make a conscious approach to Newcits funds.

Massimo Mazzini

CEO of Eurizon A.I. SGR and CEO of Eurizon Capital S.A.

1 Directives 2001/107/CE and 2001/108/CE.

Introduction: The Crisis of 2008 and the Way Out

UCITS can be as important to the fund industry as the GSM was for mobile phones. GSM allowed European mobile phone companies to dominate around the world, except for in the US.

Paul Marshall, co-founder of Marshall Wace LLP

The hedge fund industry closed the year 2009 with returns that represent the best result of the last decade. According to our calculations, at the end of 2009, 83% of hedge funds generated positive performances in 2009 and 22% recouped completely the losses of 2008. Hedge Fund Research estimates that at the end of 2009 the hedge fund industry managed $1,600 billion, which was up from $1,400 billion in the previous year, but well below the peak reached in 2007 of $1,868 billion. The number of hedge funds is progressively declining from a peak of 10,096 at the end of 2007, to 9,284 at the end of 2008, and to 9,050 at the end of 2009. Morgan Stanley foresees that at the end of 2010 the hedge fund industry will reach $1,750 billion of assets under management – a level similar to that reached in mid-2007. After the crisis, 2010 appears to be a year during which investors will regain confidence in hedge funds thanks to easier operation, transparency and liquidity than in the past.

At the end of 2008 some critics were laughing: “Do hedge funds still exist?” What happened in September 2008 had no precedent in the history of financial markets and marked the worst month ever in the history of hedge funds. Some interpretations of what happened in that month can help to explain how the hedge fund industry shook under the effect of severe attacks on its foundations.

The first point to consider is the questioning about two pillars of the hedge fund strategies: short selling and leverage. The starting point is represented by the events that happened in September 2008. In the first weekend of September, Fannie Mae and Freddie Mac entered into conservatorship. Lehman Brothers International (Europe) filed for bankruptcy protection on 15 September 2008. With $639 billion of assets, its bankruptcy was six times larger than any other in US history. Furthermore, Lehman had an “investment grade” rating when it failed. This highlighted the fact that the financial leverage used by hedge funds came from brokers where little attention was given to the segregation of client assets from bank assets. Practically, hedge fund assets were often kept in omnibus accounts rather than in non-rehypothecated segregated accounts, and when Lehman Brothers International (Europe) failed, the lack of segregation of assets between hedge funds and prime brokers caused extraordinary financial distress in several hedge funds. In fact, Lehman was the prime broker of several hedge funds and the lack of segregation of assets made it possible for Lehman to rehypothecate the hedge fund assets. Even where Lehman was not the prime broker, they were counterparty to the numerous trades for many hedge funds. In the end, many hedge funds were in a position of unsecured creditors in Lehman’s bankruptcy and it became impossible for them to value their portfolios. For this reason, many hedge funds created side pockets, with Lehman claims inside. The reaction of market regulators and politicians to that frightening series of defaults, and to the fall of share prices of financial institutions, was a ban on short selling. That ban made it extremely difficult to work for hedge funds that specialized in long/short equity, equity market neutral, convertible bond arbitrage and statistical arbitrage strategies. Those funds, which were used to applying relative value strategies on shares of the financial sector, were forced to limit their exposure to the financial sector.

A second point to consider is the impact of idiosyncratic events on hedge fund performances. We refer in particular to the extraordinarily large short squeeze on Volkswagen shares that occurred in the autumn of 2008. Long before that, many hedge funds had realized that the auto industry would have suffered greatly in that phase of the economic cycle, so they shorted shares of auto producers like Volkswagen. In addition, Lehman was particularly active in borrowing Volkswagen stocks. Suddenly, Porsche announced to the market that it had accumulated a large stake in Volkswagen stocks through derivatives. During the last week of October, the hedge funds that sold short Volkswagen shares were forced to buy back shares in a market with few floating shares. In a joke, Sergio Marchionne, CEO of Fiat, said that Porsche was a hedge fund that also produces cars. On 27 and 28 October, Volkswagen grew to approximately five times its previous value, causing enormous losses to hedge funds that were short that share. BAFIN did not suspend Volkswagen shares for its excessive rise and there were polemics about the lack of transparency in the way Porsche had built its stake in Volkswagen through derivatives. As anticipated, this event – isolated but nevertheless very important – offers an interesting perspective that shows how dangerous short selling can be when risk management procedures are not sufficiently robust.

Another perspective to consider is the role of over-the-counter markets during the crisis, in particular credit default swaps. At the end of 2008 large defaults, both bankruptcies and technical defaults, poured out their effects on the credit default swap market, whose notional value was estimated to be about $45–60 trillion or up to four times the entire US GDP. The outstanding amount of credit default swaps on a single company was uncertain and the tangled web of relationships among counterparties cast dark shadows on the solvency of some large financial institutions. In particular, there were many concerns on the settlement day for technical defaults of credit default swaps for Fannie Mae and Freddie Mac, which caused cash settlements of some $80 billion. The events of technical defaults on credit default swaps on Fannie Mae, Freddie Mac, Lehman, General Motors and Chrysler tested – for the first time and on such a large scale – this enormous market of over-the-counter derivatives, raising concerns on counterparty risk. Despite all cash settlements having a successful conclusion, the absence of a clearing house to manage counterparty risk was perceived for the first time as being unsustainable. In those days, it seemed clear that such a large market could not be unregulated. Again, the hedge funds were in the eye of the storm as they were one of the main users of credit default swaps. After the policy error of allowing Lehman to fail, the US government was obliged to nationalize AIG because that organization had a huge portfolio of credit default swaps and it was very clear that default by AIG would have had a domino effect on other banks.

An important milestone has been the debate on the transparency of hedge funds. On 11 December 2008, the arrest of Bernard Madoff caused an unprecedented crisis of confidence in hedge funds. Bad press about this $50 billion Ponzi scheme convinced politicians that they could not delay the regulation of the hedge fund industry. Madoff pleaded guilty and was sentenced to 150 years in prison. This is probably the reason for the increased oversight of SEC on hedge fund managers, and the new proposed regulation by the European Commission for offshore funds. Extremely important were the redemptions received by hedge funds and funds of hedge funds at the end of 2008. Around 20% of hedge funds restricted liquidity for their investors because they found an imbalance between the liquidity of the assets in their portfolios and the liquidity they promised to their investors. One hedge fund in five used side pockets, redemption gates, payments in kind, suspension of the calculation of the net asset value (NAV), or often restructured redemptions using very complex legal documentation, which sparked the anger of the redeeming investors and, in particular, of fund of hedge fund managers.

Other core activities of the hedge fund industry were put under discussion. Hedge fund managers often invest a substantial amount of their net worth in the fund they manage in order to provide an alignment of interests with the other investors. In some cases, however, this caused larger liquidity restrictions because the hedge fund managers wanted to continue being investors without paying redemption costs caused by redeeming investors, and without remaining invested in a fund with a higher percentage of illiquid assets. The crisis highlighted the role of proprietary trading desks of large financial institutions, which was very similar to that of large hedge funds. In January 2008, Société Générale announced a record loss of €4.9 billion from its proprietary trading desk.

Another pillar of the hedge fund industry is the high watermark, which is the calculation of performance fees only if the hedge fund exceeds the historical maximum of its NAV. As has been said, this aligns the interests of the fund manager and the investors. Nevertheless, during the crisis many money managers preferred to liquidate the funds that, because of the losses, were too far from the high watermark, otherwise they would have managed the funds for years without earning performance fees. In the second half of 2008, according to Hedge Fund Research, 1,122 hedge funds were liquidated. Too many hedge fund managers chose to liquidate the existing funds and to launch new funds with a new high watermark, showing a moral hazard. This dynamic of asphyxiating launches of new funds can also be explained with higher barriers to entry in the hedge fund industry caused by higher legal costs, compliance costs and internal audit costs to comply with the more stringent regulations.

Another perspective relates to the arrests for insider trading that highlighted the illegal practices of some hedge fund managers.

In this introduction we have shown some interpretations of the financial crisis that have so undermined the foundations of the hedge fund industry that it is impossible for hedge fund managers to continue to do business as usual. Owing to the crisis we are obliged to rethink the strategies of both the hedge fund industry and the fund of hedge funds industry. Nevertheless, hedge funds still exist. A strong need for money management services clearly emerges from the crisis. After all, we are still convinced that hedge fund strategies are very powerful investment tools that allow investment ideas to be expressed in an asymmetric way. Investors are still interested in absolute returns and, at least in perspective, the hedge fund industry has the tools to implement strategies that are able to generate returns that are not too correlated with financial markets. The reaction of hedge fund managers to the crisis has been very different. Some large and well-known hedge funds shut down their activities under the weight of their negative performances. Other hedge fund managers continued to work as usual, thinking that the crisis was not different from past crises. Some others have discussed their operations, creating working groups or best practices to self-regulate themselves but have produced only limited effects. Last, but not least, some others chose the ease, transparency and liquidity offered by the UCITS III directive, which provides a regulatory framework that is well defined and designed to protect the final investor. These money managers found in the existing UCITS III directive a way out from the general lack of confidence that was surrounding the hedge fund industry.

Paul Marshall, founder of the London-based asset manager Marshall Wace LP, compared the UCITS III directive to the GSM standard for mobile phones that has given European mobile phone companies a competitive advantage all over the rest of the world. We believe that the essence of his statement is the role that standardization can have on the asset management industry: ease of operation, liquidity, asset protection, diversification, risk management processes and transparency. Moreover, the UCITS III directive moves the fund domicile from offshore fiscal havens to European countries, fighting against regulatory and tax arbitrage. This directive provides another way out for alternative asset managers and so, in a nice syllogism, pushes hedge fund managers to become mainstream and more and more traditional. The subject of this book is to study this way out in detail, to discuss the possibilities provided, the missed opportunities, and to describe how this new phenomenon is growing. The discussion will follow a top-down view. In the first chapter the UCITS III directive is presented, its contents are discussed and the implications for asset management companies are highlighted. We also mention the evolution of the regulatory framework. In the second chapter, we project the new regulatory requirements on the asset management companies, determining the different business models that money managers can choose if they accept to be compliant with the new regulatory framework. The third chapter is dedicated to the description of the operational models of Newcits. The fourth chapter focuses on hedge-like strategies that can be implemented under the constraints of the UCITS III directive. Finally, the last chapter focuses on Newcits, describing the first steps of this new-born industry in term of characteristics, performances, fee structure and analysis of tracking error in respect to the corresponding offshore funds. Our considerations about the effectiveness of the UCITS III directive and potential developments conclude the book.