Private client managers would view hedge fund products more favourably if regulated offerings became...
Private client managers would view hedge fund products more favourably if regulated offerings became available, says Jenne Mannion. Meanwhile, demand is already growing rapidly among advisers
Hedge funds would have far more appeal if there were regulated options products available and if returns were deemed as capital gains for taxation purposes.
These were among the key findings from exclusive research commissioned by Incisive Research, a division of International Investment's parent company Incisive Media earlier in 2006. The research involved surveying wealth managers about their use of hedge funds in private client portfolios.
Figure 1 shows that 75% of wealth managers ranked a format that enabled returns to be deemed as capital gains for taxation purposes as the most important factor.
That would mean clients could benefit from using their annual allowance (in 2006/07 £8,800) to reduce their tax liability.
Bridget Guerin, a director at the Matrix Group, says the industry is starting to look at ways to address this demand and, consequently, has started to develop products.
For instance, Matrix launched the closed-ended Matrix Max fund as a sub-fund of Matrix Structured Products Limited, a Bermuda-based closed-ended segregated accounts company. The fund invests 100% of its assets in the shares of the open-ended Matrix Max fund and any gains are subject to capital gains tax rather than income tax.
However, John Chatfeild-Roberts, a fund of hedge funds (FoHF) manager at Jupiter Asset Management, says he is concerned by the high amount of people who consider the tax regime above the inherent benefits of the product they are buying.
"That indicates to me that these advisers would really only look at certain types of hedge funds or FoHF," says Chatfeild-Roberts. "Products where gains are taxed as income are less likely to be considered."
Nearly 40% of wealth managers surveyed said they would consider using hedge fund products within a client portfolio (figure 2). Chatfeild-Roberts says he is not surprised that less than half of advisers still do not use these products because the FSA has made it difficult for intermediaries. As a result, there is a widespread opinion that FoHFs would become more popular if regulated products were to become available.
He says: "Some advisers are on a hiding to nothing because they don't have regulatory back up. If they don't have time to do the due diligence and a hedge fund product turned out to be less good advice than just buying an equity fund (simply because the long-only fund went up more) that could cause problems."
Mick Gilligan, head of research at stockbrokers Killik & Co, says the regulation of hedge funds would make life much easier. Gilligan, whose company holds some hedge funds on behalf of private clients, says: "It is one thing to include hedge fund products in clients' discretionary portfolios in a limited way. However, if actively promoting hedge funds to clients, there are restrictions in who you can promote them to. Being able to regulate hedge fund products will help to boost the availability of products and demand."
There also appeared to be strong interest in products that can be launched under the amended Coll Source Book and linked to single strategy hedge funds (see figure 3). The main reasons being that these are regulated and offer higher transparency.
"There is almost certain to be an increase in hedge fund products of this type. Once there are enough of these in the market, I expect there will be fund of funds products that will look to invest in these," Guerin says.
Such an example is Merrill Lynch's UK Absolute Alpha fund, managed by Mark Lyttleton.
Guerin says the merits of hedge funds came to the fore amid the three-year bear market that ended in March 2003. Falling markets demonstrated the beneficial role hedge funds could play due to their non-correlation with other assets and the fact they could make absolute returns in falling markets. "Given the bull market more recently, the performance of hedge funds is not so impressive in relative terms. They are likely to become increasingly popular if there was another bear market," she says.
This view is backed up by 47% of respondents who said if the stock market were to move back into a bear phase, they would increase their exposure to hedge funds (figure 4).
Although hedge funds are often criticised for their high charging structure, it seems wealth managers are prepared to pay up. Figure 5 shows 64% of respondents found charges on single hedge funds, which levy a performance fee, to be fair.
In any case, wealth managers are little concerned by hedge fund fees, provided they perform well. Figure 6 shows most respondents (50%) felt a fee of 2%-3% was a reasonable TER on a FoHF that delivers a good return.
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