Newcits funds: the risks are underestimated, say experts

A panel of leading experts think the rise of Ucits III hedge funds need not cannibalise the hedge industry's traditional client base, but that many people are underestimating the risks involved with these Newcits funds.

The four man panel at Deutsche Bank's Newcits event in London consisted of Michele Gesualdi from fund of hedge fund specialist Kairos Investment Management, Pascal Botteron, global head of hedge fund investments for Deutsche Bank's private wealth management arm, David Miller, director of Cheviot Asset Management, and Dr Bernhard Steege, senior analyst at German consultant Albourne Partners.

A central point of the discussions was how the rise of such funds have created a huge new potential client base for hedge fund managers.

'We are seeing demand from life insurance firms and pension funds, who would never before have touched hedge funds,' said Deutsche Bank's Botteron. 'So what is most interesting about these funds is that they can really diversify a hedge fund’s investor base.

'At the same time we are seeing all the big mutual fund houses trying to escape and enter the other space. The convergence between the hedge fund world and the traditional mutual fund world at the moment is absolutely amazing. The world is changing.'

Gesualdi said the most important part of dealing with this new wave of funds is finding new investors, rather than selling them to existing hedge fund clients- which would be the 'biggest mistake'. 'They need to be sold to different clients, with different fees and with different levels of risk appetite. They should be sold to retail clients and institutional investors,' he said.

Fund of hedge fund manager Gesualdi added that 'in two to three years time, our business will predominantly be with Ucits funds.'

Consultant Steege said the rise of Newcits funds 'is a game changer,' which will have major consequences in his homeland. 'I am from Germany, where we are known for our dislike of hedge funds. Suddenly there are all these hedge funds appearing as regulated vehicles, which effectively have government approval. And you know how much Germans like government approval. So, those investors in these Ucits funds from the German speaking world will be new to hedge funds and so they will not cannibalise hedge fund clients.'

However, sentiment among the panel towards these new funds was not all positive and they were all keen to point out the risks. 'I’ve heard hedge fund investors say that with Ucits III due diligence is not necessary. I completely reject that,' Steege said.

Steege also added that the funds face regulatory risks: 'We have AIFM, we have Ucits IV and the industry is already talking about Ucits V. How will that evolve? Also, traditional hedge funds have side pockets and gating mechanisms to manage liquidity, the Ucits funds do not have these.'

Deutsche Bank's Botteron has so far rejected a large number of Newcits funds from entering his wealth management recommendation list due to their risks. 'I have looked at 100 of these funds, rejected 50 and accepted 25. There are a lot of risks, even though they are Ucits III and regulated. They are full of risk and due diligence is very important,' he said.

Gesualdi, meanwhile, voiced his concern that Newcits funds may become too complex for regulators to properly comprehend. 'One of the things I don’t like is where they use swaps to replicate the offshore fund. I am worried about that trend and don’t think the regulators really understand it.'