Patric Foley-Brickley, Head of Institutional Business Development & Client Management in the UK, discusses starting a UCITS fund and the implications of a possible hard Brexit. We reproduce the interview he held with HFMWeek.
Q: What are the practical considerations to bear in mind when starting a UCITS fund?
A: There are two fundamental questions I would typically ask a manager expressing interest in setting up a UCITS fund range: firstly: ‘what’s your investment strategy?’ in order to determine whether it’s suitable for the UCITS environment; and secondly, a two-part question, being: ‘who are your target market investors and where are they?’
UCITS is primarily a retail vehicle, but in the European institutional space a UCITS fund also has the advantage that it’s a well understood product and that the investments will be managed within a tightly controlled regulatory framework. From this standpoint, it’s relatively easy to market to the establishment of European retail and institutional investors.
However, there are other challenges and from an investment strategy perspective the rules governing a UCITS are quite proscriptive.
The appropriateness of a UCITS fund will depend on whether the manager can fit their investment strategy into those proscriptions. For a long-only equity/bond manager or predominantly long-only manager that uses some limited hedging and EPM techniques to produce alpha then such strategies will generally work well in a UCITS environment.
If the strategy is more aggressive, incorporating illiquid securities, short-selling, real estate or private equity investment, then a UCITS will not be an appropriate vehicle.
From a marketing perspective, it is important for the prospective manager to have identified both the intended target market investors and the jurisdictions in which those investors reside. Does the manager intend to market broadly across Europe and beyond, or keep their strategy confined to a particular European jurisdiction? It is important to be selective and to focus the marketing to a finite number of well-researched jurisdictions from the outset. UCITS funds benefit from the EU cross-border marketing passport, but there are varied and specific requirements in each jurisdiction which come with associated additional costs for fund registration and the translation of the fund documentation to meet local requirements. These additional expenses can have a marked effect on the overall running costs of the fund, particularly when the asset base is small.
In that respect, it’s also important that a new fund achieves critical mass within a relatively short period of time as the ongoing costs of running a regulated fund are not inconsiderable. Assets under management (AUM) of around $50m generally constitutes sufficient critical mass for the fund to operate without the ongoing charges figure (OCF) exerting an unacceptable level of drag on the overall performance. As an absolute minimum, $20m may be sufficient; but at this level of AUM the fund manager may need to subsidise the OCF at the expense of their own profitability. However, an AUM of this amount will at least give them the opportunity to establish a performance track record and enable them to establish a toehold in the European market.
Commercially, managers need to be aware that unless they can achieve that critical mass and an above-average performance track record, the money isn’t going to simply ‘flood in’. Europe is a relatively reactionary market and investors will tend to bide their time before deciding to invest with a new entrant, no matter their track record and reputation in other parts of the world.
In summary, if a manager is trying to penetrate the European retail and institutional market, a UCITS fund is the perfect vehicle, provided the investment strategy can be accommodated within its guidelines; it ticks all of the right boxes both from a cross-border regulatory perspective and from the perspective of being well understood by European investors. But the perennial challenge remains – to find investors willing to invest with a new entrant in an already overcrowded market.
Q: What is the current outlook on Brexit?
A: The current thinking is that the EU marketing passport for Britain will go away. This has implications for not only UK managers who want to market into Europe, but also for European and other external managers who want to market into the UK. Without the marketing passport, a manager inside or outside of the UK will almost certainly need two sets of funds; one for marketing in the UK, and one for the rest of Europe.
For UK managers, a hard Brexit will mean that they will need to set something up in an EU jurisdiction such as Luxembourg or Dublin. Similarly, EU fund managers who have been marketing Luxembourg or Dublin funds into the UK will almost certainly have to set up a UK range.
Q: Might some managers choose to ‘ignore’ the UK market in the event of a hard Brexit?
A: It may likely turn out the other way around – if you look at the demographics and markets that buy funds, the UK is head and shoulders above everyone else in this regard. The UK has the biggest ‘invested through funds’ savings market in Europe. In Europe the majority of European savers will tend to buy domestic funds through their retail banking provider as opposed to Luxembourg or Dublin UCITS funds marketed cross-border.
While some larger managers are likely to focus on markets where they already have a footprint and who may already have a Luxembourg or Dublin umbrella, there’s also a group of managers who have relied on the passport to market their domestic UCITS funds cross-border. These managers will need to decide whether the cross-border opportunities are sufficiently large to justify the expense of running a duplicate range in another location.
Q: Have you had experience of cross-border marketing with UCITS?
A: Yes. In addition to using the marketing passport to distribute funds across the EU, we are starting to see clients making provision for the post-Brexit environment. Leveraging Maitland’s capabilities and presence in Dublin and Luxembourg we have recently helped a UK based client to launch a Dublin-based UCITS structure utilising the UCITS ‘Master-Feeder’ legislation brought in under UCITS IV. The client wished to access a predominantly continental European investor base with a non-UK domiciled fund range in anticipation of the Brave New World and we have a number of other clients who are looking closely at a similar strategy.