UCITS III came into force in February 2004 and was designed to facilitate the development of investment strategies to keep pace with market evolution and investor demand. Increased investment powers, the ability to invest across asset classes and access to returns using derivatives means that the UCITS model is flexible for fund managers to use, incorporating wide ranging investment powers.

Historically the tendency has been to regard UCITS funds as targeted at the retail market and therefore as a more ‘conservative’ or mainstream product. However, this assumption does not do justice to what has become a popular investment vehicle for sophisticated investors, high net worth individuals and large-scale institutions. Traditional asset managers have come a long way from simply long-only asset management, using a greater range of complex derivatives within the UCITS wrapper. In addition, UCITS products that aim to replicate hedge fund performance, or even index-linked products that give fund of hedge fund exposure, have become increasingly popular of late. As a result, UCITS funds have a global appeal, being successfully marketed throughout Asia as well as within the EU.

Recent events have seen the hedge fund industry facing significant challenges: plummeting AUM, depressed returns, and large scale redemption requests have resulted in a number of hedge funds and their managers simply ceasing to exist. Although forecasts indicate that recovery is coming and the industry should rise again, it is clear that the landscape will have changed dramatically. Recognising the need to adapt to the changing environment many hedge fund managers have begun to look to the opportunities in the regulated fund world, often teaming up with mainstream asset managers, to adjust hedge fund strategies to those permitted in a UCITS fund, thus facilitating capital raising in these difficult times.

There are a number of advantages to operating in a regulated market rather than in an unregulated jurisdiction such as Cayman. In addition, the growth in the number of UCITS funds in Luxembourg and Ireland in particular reflect the attractiveness of the product. These jurisdictions have streamlined their regulatory and tax systems, seizing upon the opportunities offered by the UCITS framework.

Whilst the currently preferred domiciles for UCITS funds, by a large margin, are Dublin and Luxembourg, the management of these funds often sits largely in the UK where the investment professionals are located. More recently the UK authorities have tried to improve the competitiveness of the UK funds market by giving UK funds greater clarity on the distinction between what constitutes ‘trading’ as opposed to ‘investment’. Draft legislation has been published, providing a white list of transactions for UK authorised investment funds (AIFs) which mirrors the list of ‘investment transactions’ that qualify for the UK Investment Manager Exemption, a set of tests long familiar to the hedge fund industry.