UCITS: Expensive, Complex, Worth it?

Europe and the U.S. may be viewed as Western titans in the public sphere, but there are certainly unique differences between the two juggernauts. Whether it’s food, culture, or politics, each region has its own flavor. One of those differences as it relates to investing which is gaining more and more notoriety is the rapid increase in the popularity of so called UCITS funds.

While the European regulatory framework is well outside of our expertise, we have been getting somewhat frequent questions regarding UCITS (What are they? What do I need to know?), and decided to dig a little deeper into UCITS funds.

UCITS stands for ” Undertakings for Collective Investments in Transferable Securities.” It was developed as a European Directive in 1985 as part of an EU effort to establish a single market for financial services in Europe via a unified regulatory framework for mutual funds. The goal was to eliminate the need for managers to go through the red tape of each country, and instead create a single set of rules which managers could follow to promote their products in all EU member states. The benefit for investors was consistent protection no matter what country the product was originated in.

Essentially, the idea is the same as a mutual fund here in the US, where the company putting the fund together can forego having to comply with the rules in all 50 states by complying with an overarching Federal set of rules (a registered investment company) instead.

Well, the UCITS folks are now on their fourth version of the directive and it finally seems to be getting legs and gaining a market share in Europe. We went in search of more answers surrounding how this works from a managed futures perspective, but unfortunately found more questions than explanations.

UCITS is essentially a very complex briar patch of regulations that is next to impossible to interpret without some guidance. Seek clarification on terms used, and you’ll find six different interpretations of the rule. The lack of clarity makes it seem like more of a hassle than it’s worth.

Here were our take aways:

• There’s no established system for paying taxes on the investments if you live outside of Europe. For our clients in other parts of the world, that’s close to a non-starter.
• They’re expensive to launch, costing hundreds of thousands in initial fees. Add to that the extra you’re paying to have legal counsel keep you compliant with the aforementioned briar patch, and it ain’t cheap.
• Part of the regulations limit global exposure and mandate certain margin-to-equity ratio levels. The best translation of this that we’ve found? Commodity exposure is limited, and positions can be thrown for a loop if an investor withdraws a large amount of funds if the manager wants to stay compliant with those margin-to-equity requirements.
• We’re still not clear on what kind of commodities can be invested in. Some places say it’s fair game. Others say it has to be indices reflecting the commodities. We know there’s a so-called “trash ratio” that allows you to invest in “non-eligible” assets, but that it can only be 10% of the portfolio. Depending on how this is implemented, we’re not sure how some CTAs would function under the UCITS seal.
• There’s some conversation on UCITS funds not tracking the performance of the programs they were derived from… at all. This comes down to tracking error created by a minimum investment/fund size mismatch. Imagine a program which takes one contract of Crude Oil for every $500,000 in equity. Say they have $5million and 10 contracts of Crude Oil held in the fund. Now what happens when someone adds $200K to the fund?  The program can’t add 2/5 of a contract easily, so there becomes a mismatch between what is supposed to happen in the program and what happens in the fund. One high profile firm we spoke with which has chosen not to go down the UCITS path cited just such a funding mismatch as their reason for passing on a UCITS fund – saying the liquidity requirements can create a problem where the fund is either over or under represented in certain contracts.

We were able to get one European managed futures participant on the record, speaking with Alistair Evans of Qbasis Invest. Despite their European roots, Qbasis chose instead to launch an ETF that tracks their performance last year, and most recently, an index that does the same. He believes that this may become a bigger trend in Europe, as funds try to secure investor confidence without paying the high premium associated with launching and maintaining a UCITS fund.

Bottom line: While UCITS funds may appear to be a good thing for the investor, the complexity and issues inherent in it can cause underperformance issues that need to be considered. Is the ease of access worth the potential under performance is a choice for each investor.

From the manager standpoint, the high cost of setting up and maintaining a UCITS fund appear prohibitive for anyone but the largest of large managers (several hundreds of millions under management). Managers must also consider the level of complexity in following the rules in terms of liquidity and opportunity cost of not being able to match their model to the funds funding completely.