As regular readers of AllAboutAlpha.com know, one needs to look beyond superficial labels such as “hedge fund” and “mutual fund” in order to understand the shifting asset management landscape.  As we like to say, it’s not about “hedge funds” or “mutual funds”, it’s all about alpha.

So we were very interested to read about this issue from a legal perspective on an excellent website called The Hedge Fund Law Report.  The site produces mainly in-depth articles and is subscription-only.  However, we are pleased to reproduce in its entirety, a recent article that illustrates how evolving European mutual fund regulations are fuelling the convergence of hedge funds and mutual funds.

Convergence of Hedge Fund Strategies and the UCITS Structure in Europe Mirrors Convergence of Hedge Fund Strategies and Mutual Fund Structures in the United States

By: Christopher Faille, The Hedge Fund Law Report

Undertakings for Collective Investment in Transferable Securities (UCITS) – retail investment funds authorized by one of the member states of the European Union (EU) and thereby passported into the rest of the EU – represent the dominant platform for retail investment funds in Europe.  See “UCITS: An Opportunity for Hedge Fund Managers,” The Hedge Fund Law Report, Vol. 2, No. 27 (Jul. 8, 2009).  Collins Stewart, a London-based financial advisory group, recently announced that it plans to launch a fund of funds within the UCITS structure.  This announcement, and a similar announcement from Schroders PLC that it is working with hedge fund managers to launch a range of UCITS funds for sophisticated investors, serve as evidence of the increasing convergence of hedge fund strategies and the UCITS structure.  The convergence mirrors a similar trend in the U.S. in which hedge fund strategies are being offered in mutual fund or exchange-traded fund vehicles.  These trends on both sides of the Atlantic are part of a more overarching trend toward retailization of hedge fund strategies, which heretofore have been the exclusive province of high net worth individuals and sophisticated institutional investors.

Retailization can dramatically change the game for hedge fund managers.  Among other things, it can open up a vast new market for their services.  See “Hedge Fund Managers Launching Mutual Funds in an Effort to Stay a Step Ahead of Regulatory Convergence,” The Hedge Fund Law Report, Vol. 2, No. 15 (Apr. 16, 2009).  But at the same time, it can dramatically increase the number and heft of competitors, and can introduce a variety of new conflicts.  See, e.g., “New Study Offers Surprising Findings on the Incentives Created by Concurrent Management of Hedge and Mutual Funds,” The Hedge Fund Law Report, Vol. 2, No. 23 (Jun. 10, 2009).  A related trend is so-called hedge fund replication, in which hedge fund strategies are supposed to be reproduced in non-hedge fund, often retail, vehicles.  See “Hedge Fund Replication is Gaining in Popularity, but is it a Viable Alternative to Hedge Fund Investing?,” The Hedge Fund Law Report, Vol. 2, No. 28 (Jul. 16, 2009).

This article examines retailization on the European side.  In particular, it analyzes the promise, limits and mechanics of the UCITS structure; replication as an alternative route to retailization; the likelihood that the onerous Alternative Investment Fund Manager (AIFM) Directive may increase the use of UCITS funds for hedge fund strategies; and how UCITS IV will change structuring and management of UCITS funds, focusing on increased ease of passporting, new rules regarding fund mergers and master-feeder structures and new standards for risk measurement and management. More…