Given the growing popularity of Europe's Ucits scheme among distributors in Asia and even the US, it was only a matter of time before an Asia-based hedge fund used the structure to offer a product in Europe.
That time has arrived, as Hong Kong-based Galaxy Asset Management has chosen to launch a Ucits III version of its Galaxy China Opportunities Fund using Dublin-domiciled Ucits platform Merchant Capital. The fund is likely to be available by September at the latest and targets $500 million in assets within a few years.
The fund will initially be aimed at institutional and high-net-worth investors in Europe and Asia, with a minimum subscription of €100,000. The existing China Opportunities Fund has a five-year track record, having launched in 2005.
"We'd been considering forming our own Ucits structure, but we decided there were too many things to handle and organise ourselves," says Johnson Cheung, managing director focusing on portfolio management and research at Galaxy AM in Hong Kong. "We felt doing this under the Merchant umbrella was the fastest and most efficient way to go.
"We also like the fact they don't have a dedicated China fund on the platform already," says Cheung, adding that Merchant already has a track record. Indeed, George Cadbury, director of funds at Merchant Capital, says this is the first China long/short fund to be put into a Ucits structure and one of the first managed out of Asia.
Presumably Galaxy also has one eye on the proposed European Union directive on alternative investment fund managers (AIFM), which may severely restrict the sale of non-EU-domiciled funds within the eurozone.
However, Cheung says investor demand for greater liquidity was more of a driver behind the Ucits fund launch than concern over the AIFM directive. Some of Galaxy's existing clients -- largely institutions and family offices -- had wanted higher liquidity and to have the fund sold onshore. In addition, having a Ucits structure means the firm will be able to access retail investors, says Cheung.
Galaxy is still in talks with Merchant, prime brokers and investment banks over how it will tweak the fund to ensure it complies with Ucits rules on liquidity, transparency and so on. One issue is that the manager will have to use swaps for hedging purposes, since Ucits prohibits direct short-selling of stocks, and it will also need to adopt different liquidity terms. Currently they are monthly, but they will need to be weekly or daily for the new version.
"The main issue will be managing the downside volatility, as there'll be more restrictions on short selling," says Cheung. "It will be slightly more expensive to do hedging using a swap structure."
Asked whether investors are concerned about returns suffering due to the stricter requirements, Cheung says performance could certainly be affected, but clients are seeking liquidity above all at present. Still, he feels it will not dramatically hurt performance, as the fund focuses on large-cap stocks and manages the portfolio "quite dynamically".
Since inception, the China Opportunities Fund has averaged annual returns of 22-24% with a Sharpe ratio of 1.2, and Cheung feels the Ucits version will achieve largely similar performance.
"We will be more mindful of overall exposure as well," he says, adding that gross exposure for the existing fund ranges between 70% and 150% and for the Ucits fund is expected to be 20-30 percentage points lower.
The Galaxy China Opportunities Fund invests in the Greater China markets and focuses on four key strategies: position-taking (alpha generation by stock/sector picking, both long and short), special situations (IPOs, M&A, structural opportunities, reverse takeovers and asset injection), long/short (hedged opportunities) and tactical trading (futures & options and arbitrage).
The fund is idea-driven, typically holding around 50 stocks at any one time, excluding positions in arbitrage activities. It employs both a top-down and bottom-up approach, reinforced by technical analysis and market intelligence, and is invested mainly in mid- and large-cap opportunities.
Cheung and Joe Chan will act as advisers to the Ucits fund under the Merchant umbrella. Between them they have over 40 years of combined experience in financial markets. Previously, Chan worked for Morgan Stanley in Europe and Hong Kong, where he headed non-Japan Asia equities trading and risk management. He left Morgan Stanley in 1996 to form Galaxy.
Cheung, formerly of Goldman Sachs, joined Galaxy in 2007 and became its managing director, focusing on portfolio management and research.
Cadbury says Merchant is also in discussions with other Asian firms looking to launch Ucits products, the large bulk being long/short managers, but they also include some global macro and currency-focused funds. There are certain types of funds -- such as those that invest in commodities or use significant leverage -- that aren't compatible with Ucits rules, he adds.
"There appears to be a lot of demand for Ucits from Asian investors, as well as from Europeans," says Cadbury. "The US is also trying to pick up on how they can use it.
"Historically, if you wanted to get involved in Ucits you had two options," he says. "Either you did it yourself, which could be cripplingly expensive or time-consuming, or you can use one of the banks' platforms."
To offer a third alternative, Merchant created a Dublin-domiciled Ucits umbrella structure, which can appoint managers -- subject to due diligence and regulatory approval -- anywhere in the world and get them on board within six to eight weeks, says Cadbury. Previously it typically took three to six months to construct and bring to market a Ucits product.
Merchant opened its office on January 18 and has signed up four firms since then, including Spanish funds distributor Tressis.
As investment manager of the Ucits III umbrella, Merchant appoints the client as adviser or sub-manager of a sub-fund or 'cell'. This cell is managed according to the client's instructions while Merchant manages the oversight, administrative, processing and regulatory functions. Independent trustees are appointed, as per the Ucits requirement, and this is also a due-diligence prerequisite for many investors.