With all the media hype directed at the Ucits III and Nurs structures, it is a good idea to look at what powers these new conversions will bring and how best to use them, says Gill Hutchison, investment research manager at Old Broad Street Research
Much has been written and spoken about Coll conversions and the new powers available to fund managers under the Ucits III and Nurs structures. But, in practice, what is this brave new world? How will it impact upon the products we recommend to our clients? It seemed a good idea to look in more detail at these new powers and how they are - or will be - used, with particular reference to multi-manager funds.
First the dull bit. In this world of acronyms, it is worth recapping on what some of them stand for and give a brief background to the regulations. The original Undertakings for the Collective Investment of Transferable Securities (Ucits) directive was passed in 1985 with the objective of allowing open-ended funds that invest in transferable securities to be subject to the same regulations in every member state of the EU without further authorisation.
This sounded good in theory but, in practice, European countries created obstacles to the cross-border marketing of Ucits funds. Also, permitted investments under Ucits were limited, which restricted fund managers' investment opportunities. Discussions aimed at overcoming these issues took place and, in 2001, two Ucits III directives were adopted. They were implemented in the UK a year later with further amendments introduced in 2004.
The Financial Services Authority (FSA) requires all funds established under Ucits I to convert to Ucits III or Nurs - short for non-ucits retail schemes - by February 2007. Nurs funds can take advantage of wider investment powers than Ucits III funds, but their distribution is limited to the UK. Last year, Nurs schemes were made eligible for the stocks and shares component of Pep and Isa schemes, subject to certain liquidity requirements.
In a recent development, the FSA has proposed that Nurs funds should be automatically eligible for life and pension funds without the current waiver system, commenting that restrictions on their inclusion are difficult to justify. The new Ucits III and Nurs rules have been introduced by the FSA's new Collective Investment Schemes Sourcebook, known as Coll, and this replaces the existing sourcebook.
That is (a very small part of) the theory, but what has it brought to the party at a practical level? Comparing the regulations for a Ucits I and a Ucits III scheme, there have been changes in a number of areas that can have far-reaching implications for the way a fund can be managed.
One of the most important changes relates to the use of derivatives - under the Ucits I regulations they were permitted for efficient portfolio management use only, but they can be used in a much broader sense under the new regime (assuming the fund's prospectus allows for this).
This makes it easier for fund managers - if they wish - to implement directional investment strategies, which may embody positive or negative views, purely through the use of derivatives, as well as providing them with greater flexibility to hedge positions more effectively. Another important feature is that Ucits III permits full flexibility with regard to the use of cash, whereas in the past (unless otherwise stated in a fund's objectives) cash positions were permitted primarily to satisfy redemption needs.
These rules, among others, enable fund managers to be much more prescriptive about the risks they wish to take and the investment opportunities they wish to target. This new flexibility has resulted in many new absolute return and target return fund launches over the past few months.
The regulations for Nurs funds extend the permissions further in a number of areas, which renders this structure particularly popular for multi-manager providers. Among these is the ability to invest up to 20% in unapproved and/or unregulated collective investment schemes, which opens the door to alternative investments such as hedge funds.
Another important rule is that Nurs funds can offer limited redemption - to a maximum of six months - which enables them to invest in physical property. Also significant for multi-managers is the ability to increase the amount they invest in a single fund from 20% to 35%, making it easier for them to invest in funds offered by small fund management houses or funds that are being launched by managers who are known to them.
In short, the playground has just got a lot bigger. The question is, to what extent will managers be playing in these new areas? Our discussions with managers reveal some are already taking advantage of the wider investment opportunities while others have chosen to change very little or nothing at all at this stage.
A manager's decision in this regard will take into account the fund's investment mandate, the fund's investor base and the firm's own capabilities and experience, particularly when it comes to derivatives and assessing the merits of less familiar asset classes.
Importantly, where greater investment powers are utilised in the form of derivatives, fund providers are compelled to demonstrate their risk management capabilities to the FSA, which should go some way to reassure investors. Furthermore, another requirement is that the net asset value of a fund must always exceed the total derivative exposure, which means managers do not have carte blanche to leverage up the portfolio.
As mentioned above, many multi-managers are opting for Nurs structures, although some are converting to or retaining their Ucits III status and using listed closed-end funds to gain exposure to areas such as property if necessary. F&C Multi-Manager and Schroder S&P are examples of providers who have decided to remain in this structure for the time being.
Other multi-managers such as Credit Suisse, Gartmore, New Star and Jupiter have either converted or are about to convert to Nurs. For example, the Gartmore Multi-manager Cautious fund was early to convert in October last year and the ability to invest in bricks and mortar was seen by the managers as particularly advantageous at a time when they perceived fixed income to be less attractive.
Outside of exposure to direct property, most multi-managers are being cautious with regard to the new powers that Nurs provides. As mentioned earlier, in the case of Nurs and Ucits III funds, this may be because they do not feel it is appropriate to change the nature of a fund, particularly if it is long-established.
In other cases, multi-managers are now considering new investment strategies or approaches, whether that be the introduction of other asset classes or the more sophisticated use of derivatives for hedging or strategy purposes. Nevertheless, there is a general air of caution, with compliance departments also monitoring new activity very carefully. Some groups are adding to resources in the acknowledgement that a greater number of funds and investment types now need to be covered.
It is in the managed sectors where the range of possibilities is clear to see. Some funds remain invested simply in bonds, equities and cash. Elsewhere, property is now used more frequently, thanks to the change in regulations. Cash weightings can vary significantly as some managers are using risk-free assets more actively.
Other investment types such as private equity, absolute return funds, structured products and currencies are beginning to feature more often. Commodities have been a popular investment theme over the past few months, but it will be interesting to see if any managers decide to take advantage of the Nurs permission to invest up to 10% in physical gold.
The change in the regulations should be seen as a positive development as it is enabling the UK retail investor to access a broader range of fund types. But, as always, there are a number of important questions we should ask when we are considering these funds.
How are the new regulatory powers actually being used? What capabilities and experience does the provider have with regard to any new investment types? How are the risks being monitored? Do the new investment types actually help the fund to achieve its investment objective? In the final analysis - and, admittedly, we always seem to conclude like this - whatever you select, make sure you know what you've got.
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From 6 April 2019