Alternative Ucits’ assets under management fell 3% to $236 billion in the first quarter of the year. However, outflows have slowed and some strategy groups have even grown. Matthew Barrett, partner and head of manager research at Kepler Partners, tells Piyasi Mitra why the hedge fund landscape remains compelling.
Q: With the recent shrinking of the alternative Ucits market, do you see this as ‘natural selection’ within the industry? What signs show that better-quality funds are coming out on top?
Though the number of alternative Ucits funds is shrinking, this is a healthy process for the industry. Generally, it means the higher the quality, the more differentiated, better-performing funds remain. When you look at the universe today, though smaller, it more closely resembles the traditional ‘hedge fund’ industry compared to
its peak assets under management in 2018, when there were more fixed income-like, low-risk strategies populating the market. The funds prevailing now are higher risk, alpha-generating strategies acting as a diversifier in investor portfolios rather than a fixed income replacement. Despite the overall contraction in the universe, several funds are still limiting inflows (also known as soft-closed). This indicates there is more investor demand than capacity within alternative Ucits funds, at least for those strategies and managers with a proven, cycle-tested track record or differentiated offering. Further, funds such as MW Tops have seen relatively stable assets under management despite the general picture of outflows, showing how the popularity of some funds has endured.
“The funds prevailing now are higher risk, alpha-generating strategies acting as a diversifier in investor portfolios rather than a fixed income replacement.”
Q: The Kepler Q1 2024 absolute hedge report on alternative Ucits mentions that despite a decline in overall assets under management, certain strategies like credit, managed futures and volatility arbitrage are growing. What is driving investor demand for these strategies?
Two themes are driving this. The first is the desire for more volatile and diversifying exposures, which managed futures are well-suited for. This is a prime example of more traditional, ‘old school’ hedge fund strategies – which thrive off volatility and are more aggressive in their return-seeking – coming back into vogue. The global backdrop of macroeconomic and political uncertainty is creating more dispersion in markets, and these strategies are well-positioned to benefit from such conditions. The second is the outright money-making opportunity on offer. For example, catastrophe bond funds have entered what might be termed a ‘golden age’, with strong performance and investor demand, and have subsequently seen considerable inflows. The current return proposition of these strategies is around 8% plus cash, which is undeniably compelling for investors.
Q: With the current market backdrop posing challenges for new fund launches, what factors are crucial for a successful fund launch in the alternative Ucits space today?
Multiple factors drive successful launches – timing, quality and track record of the manager, differentiation of the strategy and market opportunities available in the focus geography. However, one key point is the need for new launches to provide genuine solutions to investor requirements. In today’s natural selection environment
within the alternative Ucits universe, funds that fail to serve a clear purpose in an investor’s mandate and portfolio are unlikely to achieve long-term success. For example, diversification is the key function of many alternative Ucits funds today.
Q: You have highlighted that the AH Global Index achieved positive performance for the 5th consecutive quarter. Can you discuss the underlying economic and market conditions contributing to this sustained positive performance?
Given the heterogeneous nature of the underlying strategies, it is difficult to tie the uptick in the performance of the alternative Ucits universe to a particular set of market conditions with absolute certainty. However, dispersion in equity markets in the UK and the US are creating opportunities for strategies such as long-short equity-
neutral funds. Higher interest rates also have a positive effect on performance. For example, market-neutral funds benefit from higher cash rates, as they need to hold a certain level of cash in tandem with their short positions – what is called the ‘short rebate’, which can sometimes be between 60-80% of the portfolio – and this can be invested into high-yielding areas like treasury bills. This naturally creates an uplift by a couple of percentages in return streams across the board.
“Within the alternative Ucits universe, funds that fail to serve a clear purpose in an investor’s mandate and portfolio are unlikely to achieve long-term success.”
Q: Given the Kepler report’s findings on the continued interest and investment in systemic strategies and growth-oriented equity specialists, how do you see the role of technological advancements, such as AI, influencing the future of hedge fund strategies within the alternative Ucits universe?
AI has permeated nearly all global industries and the alternative Ucits space is no exception. With a few exceptions, we observe that AI is being used to drive improvements in existing strategies, for example around execution or enabling further breadth in analysis.
Q: Considering the current contraction and emergence of higher quality funds, what long term benefits do you foresee for investors in the alternative Ucits universe? How might this evolution impact investor confidence and the overall stability of the industry?
Ucits funds provide investors with liquidity, which could be both a blessing and a curse, in our opinion. While this current shakeout is consolidating the universe, it should lead to a more stable industry in the long run. We still believe that diversification in portfolios is important, and many hedge fund strategies offer true, time-tested diversification which will provide utility in investor portfolios.
We hope that as the higher quality funds continue to offer an attractive risk-return profile and fulfil a clear function in portfolios, investor confidence in the industry will return to historic levels. It is important to remember that – as with all industries – the alternative Ucits space is cyclical. After a dip in assets under management and
investor sentiment, we are witnessing a smaller but higher quality industry swing back to a position of strength.
