As the alternative investment area becomes more prominent in the media and firms compete for customers, many new products are replacing the standard hedge fund structure.
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The hedge fund industry now has over $2 trillion in assets, and over 10,000 funds exist in the United States. However, the Bernie Madoff scandal and a large public distrust in Wall Street, has caused many investors to hesitate to invest in funds, which sometimes complex strategies.
Some firms have been offering hedge fund strategies in the form of an exchange traded fund (ETF), which offer much lower costs. Additionally, it gives investors the chance to buy and sell much more frequently, and at a fraction of the costs hedge funds charge. Two of the new ETFs which track hedge fund strategies are AlphaClone Alternative Alpha ETF (NYSE:ALFA) and Global X Top Guru Holdings Index ETF (NYSE:GURU).
However, some firms are offering more Undertakings for Collective Investment for Transferable Securities (UCITs), which have been in existence for far longer than hedge fund type ETFs. Recently, Karsch Capital Management, an alternative asset manager put 10% of its $2.3 billion in assets into a new UCIT run nearly identical to their flagship hedge fund.
Many investors are much more familiar with hedge funds than with UCITs. One of the reasons is that most UCITs must be based out of Europe. Hedge funds have over two trillion under management, while UCITs which manage closer to $150 billion, according to Andrew Schrage, co-owner of Money Crashers Personal Finance, and a former hedge fund analyst.
Unlike traditional hedge funds, UCITs can be sold to retail investors, and they typically bear less risk. Also, strict rules are in place for UCITs regarding the segregation of assets, conflicts of interest, and disclosure. They’re also more convenient: In some ways, UCITs present a way for investors to achieve diversification of their assets so that all of their eggs are not in the proverbial hedge fund baske: this helps explain why the structures have become a more attractive alternative to hedge funds.
UCITS have particularly become popular after the financial crisis of 2008.
Benjamin Hein, President and Chief Investment Officer of PRS Investment Advisory of affirmed this trend and states:
“Particularly after the various problems with hedge funds (such as gating) seen in the 2008 financial crisis. Many clients, both private client and institutional, felt more comfortable with the more rigorous regulatory requirements of the UCITS structure vs. the typical less-regulated offshore hedge fund structure.”
PRS Invesment Advisory is a wealth management firm with over $1 billion in assets under management, based in Miami, Florida.
Hein states that some benefits for investors in UCITs include more frequent NAV calculation and subscription and redemption terms.
However, Hein also notes that this makes it more difficult for money managers with a long term investment horizon, deal with redemptions.
“On the other hand, these same requirements may tie the hands of the hedge fund manager and make it more difficult to implement profitable trading strategies.”
This is an even bigger problem for hedge fund style ETFs. ETFs can be redeemed on a daily basis, while UCITs can be redeemed on a bi monthly basis. On the other hand, many hedge funds have lock up periods of a year or more. Some funds have penalties for early withdrawals, while others do not allow it all.
Many studies have confirmed that the more investors trade or try to time the market, the worst their returns are. The longer investors have their investments locked up, the better off they usually are. UCITs and ETFs offer more transparency and the ability to redeem money. However, these benefits can lead to lower returns and increased market volatility. Additionally, they likely will encourage fund managers to focus on short term gains, over the long term investment strategies.
While UCITs are becoming a larger part of the investment world, the jury is out on whether this will be a positive or negative.