Recent events in the absolute return industry have led investors to put a premium on transparency, accountability and liquidity. UCITS hedge funds, while not a silver bullet solution, offer investors new ways of accessing manager talent and offer managers new distribution opportunities in difficult times. The favourable regulatory and tax status coupled with lower minimums significantly broaden access to absolute return mandates and makes retail distribution a genuine possibility. However, the appeal of UCITS hedge funds is certainly not limited to retail investors as many of the benefits are relevant to institutions also. The counterparty and holdings diversification rules, as well as limits on leverage, appeal to all investor groups after recent traumas caused by problems in these areas.
However, the particulars of the UCITS directive require a new, clean method of evaluating this investment universe. Constraints on outright shorting, leverage and eligible assets mean that even simple hedge fund strategies must be implemented differently within a UCITS framework. Differing funding costs for certain strategies will become apparent and will obviously lead to different performance. Add in bi-monthly, weekly, or even daily liquidity and valuation requirements, and managing a UCITS fund on a day to day basis becomes very different from managing an offshore vehicle with a similar strategy. In essence, UCITS III hedge funds may have similar DNA to their offshore cousins but they are a breed apart.
The development of a credible and accurate UCITS hedge fund data set and benchmark is a critical next step in the evolution of this area. Without these tools, how can a fund manager benchmark their performance or an investor review their managers? How can a fund of funds truly add value without a complete view of their available investment universe?
This is why The Hedge Fund Journal, in partnership with Tomlinson Investment Consulting, is launching a comprehensive suite of UCITS-compliant hedge fund indices, which systematically brings together the disparate world of mutual funds and hedge funds under the UCITS umbrella.
In order to develop the index we started with the potential users of the data and information, what are their needs and requirements? Our research suggested that much of the currently available data on UCITS hedge funds is fragmented and does not always carve out the appropriate space for these funds’ unique set of characteristics. Currently, a number of available mutual fund data sets include funds without a performance based fee and high-water mark – are these genuine absolute returns funds or simply a neat badge for something else? Within the hedge fund data sets, the UCITS hedge funds are just lost amongst the thousands of offshore funds with much of the data richness unique to UCITS funds not captured.
The transparency and uniformity of information required under UCITS III works in the indexer's favour - no need to chase up month-end numbers, significantly less selection bias. Early on in the development of absolute-return investing on the UCITS platform, the indexer is able to strive for a high level of completeness.
Moreover, in the past the broad hedge fund industry hasn’t universally focused on the finer points of distribution, and typically hasn’t always categorised and differentiated their investor base. The “2 + 20” model is now developing as it does not always meet investors' needs. UCITS III funds offer a stratified share class structure with varying sales loads, management and performance fees possible. We intend to offer both a "retail" and "institutional" index series. Hedge fund investing is all about performance net of fees. We intend to reflect this reality in the THFJ Tomlinson Indices.
The easy option would be to shoe-horn this distinct breed of funds into either an existing mutual or off-shore fund data structure but this would miss much of the subtlety that is required to create information and knowledge from the data. We have used our expertise as former fund managers and analysts to attempt to create usable, logical and relevant categorisations. Our indices and data sets are designed by industry people to be used by industry experts but are to be delivered in a way that should be accessible and useful to all.
Just like any other index, the THFJ Tomlinson Indices will seek to adhere to principles of replicability, rules-based methodological rigour, transparency and inclusion. Difficulties with hedge fund indices are rife and well-documented - we see the UCITS platform as an opportunity to do things in a complete and holistic way. We intend to supply additional metrics in addition to performance that we hope will become the reference point for the industry.
In the next issue, THFJ Tomlinson Indices will reveal our findings after closely examining the dataset in order to provide comprehensive, representative data for the UCITS hedge fund universe. From a handful of UCITS hedge funds only two years ago, to over a hundred legitimate UCITS absolute return funds currently, and over a hundred more under consideration or in launch phase, we believe the time is ripe to embark on this endeavor.
Tomlinson Investment Consulting is a hedge fund consultancy that specialises in managed accounts and related areas including UCITS III and structured products.
