Tout bon investisseur, et le sélectionneur de fonds n’y échappe pas, se doit d’avoir un regard éclairé et critique quant aux supports sur lesquels il investit. Vincent Batailler aborde ici certains biais qui découlent de la norme Alt-Ucits : l’information surabondante mais peu utile des prospectus, les conseils indépendants de surveillance des fonds pas si indépendants que cela, les bonnes métriques des fonds à analyser…
Why the alleged safeness of Alt-Ucits funds might endanger the brand
By way of introduction, and to cut short any malicious comment, I consider European regulation safer than the more exotic ones, and thus Ucits compliant funds a priori safer than others. More generally, I am a firm believer that regulation provides more advantages than disadvantages. However, I strongly feel that, despite great intentions from the EU regulators, the UCITS V current regime carries serious adverse effects that should be dealt with and, as a first step, that every investor should be aware of. Most Alt-Ucits funds are soundly and safely managed, but not all of them.
- Providing investors with information should not consist in flooding them with useless information
EU regulators have all the same mantra: transparency. But where transparency should mean a full and fair disclosure of every valuable information, it turns often into something pretty different, at the expense of the investors and maybe, eventually, at the Ucits’ brand one.
As an example, one can be stunned by the way a prospectus of an umbrella fund, approved in 2018, describes the risks an investor bears: “Investors in each Sub-Fund are advised to carefully consider the following risks.” And then follows a list of no less than 37 different risk categories that covers no fewer than 11 pages without any specifics to such or such fund (no supplement is available). To the regulator’s request “provide information about risks”, investment firms are responding by flooding prospective investors with general and vanilla considerations of little practical interest about risks. The same applies to the markets and instruments the portfolio manager is authorised to trade. There is hardly any prospectus that does not mention the ability of a portfolio manager to trade about all asset classes, even if he is a pure equity or credit manager. Similarly, he is usually allowed to use all kinds of instruments and, most of the time has also the possibility to negotiate derivatives for both exposition or hedging purposes. Hence, it is often not that easy to differentiate a pure long-only fund from a long/short one.
As a matter of fact, I challenge anybody to fully understand the strategy as well as the risks one is exposed to by simply reading a fund’s prospectus. Hence, the fund’s behaviour could surprise investors for the worse and jeopardise the trust that the Ucits stamp inspires.
- None of the fund’s directors are required to be independent from the investment firm
Because having independent directors on a Ucits fund’s board only falls under best practices, number of directors are simply marked as such without any reference to their quality or the business they are in. If one digs a bit, it is not unusual to find out that some of them are also a director of the management company, a former executive of the fund’s administrator or still a partner of its legal adviser.
Having someone with an independent and critical view sitting on the board of a fund can trigger an investment. But what if there is a severe issue with the fund and it turns out that the director who was supposed to be independent was linked to the asset manager? Once again, the Ucits label wouldn’t emerge unscathed.
- Allowing self-custody & self-administration is sub-optimal
The UCITS V directive is notably supposed to tackle the self-custody issue (custodian and investment firm within the same group). But, aside of a transparent RFP process to select the fund’s custodian, it focuses on the limitation of cross-mandates executives could have with both the investment firm and the custodian and on the independence of a fraction of the respective boards. It seems to me broadly inadequate, mainly for two reasons. Firstly, fraudulent behaviours are not exclusive to executives and one experienced not so long ago that connections between low profiles traders and middle officers can be painful. Secondly, a director’s real independence is challenging to establish: I am not sure that regulators have the willingness and the resources to conduct background checks. Furthermore, it seems even less likely with regards to custodians vis-à-vis the directors of their sub-custodians.
I will not dwell on the Madoff case, but the risk associated to having the fund management, its valorisation and the custody of its assets being in the same pair of hands (Chinese walls are not impermeable) seems to me disproportionate vis-à-vis the interests, sometimes legitimate, of very few large financial groups.
- Neither the 20% VaR limit nor the 2x commitment approach are as conservative as one may think
A 20% monthly VaR at a 99% confidence level is far from negligible and not that binding. Furthermore, this threshold is independent from the market conditions (which can be considered for long-only funds via the relative VaR method): think about the level of leverage that is allowed as a consequence of a low volatility environment, which is usually an advance warning sign of upcoming bumpy times. Icing on the cake, the fund’s VaR is often wrongly identified with its maximum potential loss.
Once again, disillusions would be the Ucits brand’s gravediggers. I am not sure that the investors in the Alt-Ucits fund that has been shut down recently after it lost 60% within one single month were aware it could happen: its VaR was about 5%, gross exposure was below 2x and its SRI score was 4 on a scale of 1 to 7. In a letter sent to the shareholders, the management company, which is not the investment manager, wrote that they did not see any breach of the investment policy as it had been described in the prospectus. I am pretty convinced they didn’t.
- Providing daily or weekly liquidity is not necessarily investor friendly
A rationale to invest in some of the alternative strategies, especially in the Relative Value space, is their ability to capture liquidity premia. Thanks to less favourable liquidity terms and lock-up periods, typical hedge funds are legitimate in trying to harvest these premia. Consequently, they also indirectly select investors that are comfortable with long-term investments and are thus, usually, stronger hands. Despite that these strategies are, on the long run, unmanageable if the fund provides inappropriate liquidity to its investors, some are nonetheless available within a Ucits wrapper. What makes things vicious and dangerous is that most of those strategies seem to be long quiet rivers during “normal” market conditions: low volatility, interesting performances, lot of inflows. Risks build up during expansion periods and materialise both abruptly and unexpectedly. Those of us who were already in the field in 2007/2008 do remember that when the same potentially illiquid strategy was run within different wrappers, the most liquid vehicles did usually suffer a lot more than the less liquid ones.
The main issue with the Ucits regulation is that it seems perfectly under control, regardless of the strategy. As a result, I witness that some investors consider running a real due diligence on an Alt-Ucits fund as useless, and Mifid will not help to change this in the future. The devil is in the details and those details are drowned out in the myriad of information provided by the investment firms and may, sometimes, be deliberately hidden. Opacity is of course not laudable, but it entails a healthy scepticism that the regulation tends -and aims- unfortunately to mitigate. Mere information has nothing to do with accurate one. Although the Alt-Ucits space is filled with experienced and gifted people, one must remain sceptical and not replace wisdom by information.