How to define an evolving funds industry? Type Caste, UCITS III and Terminology
This essay appeared in Citywire Wealth Manager on March 30, 2010.
“There is no type; but a perverse generation is always seeking a type; so this is what the type should be.” O. Henry
Convergence and engineered evolution within large parts of what is termed traditional and alternative investments have entered a state of general acceptance. There are considerably fewer detractors to the idea than five years ago (particularly as it has become reality) but still a lot of confusion about its implications remain. With lots of loaded terminology and ardent efforts to preserve intellectual and commercial stakes (plus some general lack of understanding), discussions about the topic continue to obfuscate and baffle – this will be the case for years to come.
I have long held the view that many distinctions that divide ideas or industries into binary opposing camps are fraught with unrecognized complexities and often miss the point. The primary argument against this way of thinking is a recognition that, in human endeavors, change is the natural course. Two things, when held in relation, necessarily will impact one another particularly when one is intentionally set in opposition to the other. Their paths, sooner or later, meet again.
The “uncommon” becomes the common as the alternative becomes commonly practiced. The financial services industry provides a density of examples seconded only by perhaps art or food of the phenomena. The rate, magnitude and multifaceted nature of change in financial markets today coupled with increasing interdependencies of its parts have led to the need for rapid reworking of old ways of thinking. We just won’t “get it” using models and concepts from ten much less fifty years ago.
In early 2006, while working in Europe for Deutsche Bank, I wrote a white paper on UCITS III and its forward implications for the industry*. [While predominantly of non-U.S. significance, asset management colleagues in the U.S. with aspirations of an international business should make themselves familiar.] As much as a regulatory framework and vehicle, UCITS III or “Newcits” funds as they have been labeled, have become a garden fertile for both intellectual and commercial enterprise. After years of hesitation and chatter, the train has left the station – the conductor is yet to be determined.
Investor demand for transparency and liquidity coupled with regulatory scrutiny intensified post credit crisis and Madoff has driven tremendous interest in the U3 vehicle by a broad array of asset managers (a group in which I include “hedge funds”). Further, with the help of the growing prominence of ETFs (propelled in large part by the BlackRock/BGI deal), “active” managers of all types are now sure to ensure their fees remain feasible – they are innovating. UCITS III is the location of a powerful convergence of investment and commericial prowess.
The urge to name and categorize is fundamental to the human condition. In the asset management industry, to identify type from the single to the many and vice versa can be a curse. But this is the nature of the task of analyzing investment strategies – they are grouped into peer universes, styles and ‘asset classes’. Our use of terminology (both technical and general) becomes so loaded with a range of meaning that keeping track of just what someone intends when they use a particular term is tough. Such is the case with the adoption of language around UCITS III (though we should point out of course that this issue is not new). I am specifically thinking of the terms traditional and alternative or, as they often are diffused into, hedge funds and mutual funds.
If I had not spent so many years researching asset managers and only read the general press and listened to talking heads (not the band, the people on TV) I would be convinced that:
Hedge Fund = homogeneous group of investments that are an asset class of alpha (only) producing strategies managed by the world’s smartest investors generating absolute returns which do not correlate with “the” market and which, de facto, should be priced in the 2/20 vicinity while,
Mutual Fund = homogeneous group of unnecessarily expensive beta “managed” (but not really…) by not so smart people trying to outperform indices and only randomly generating relative returns above “the” market.
There is, of course, a further distinction to be drawn between the strategy employed by the asset manager and the vehicle through which it is delivered. Managed accounts, the oldest of the vehicles in its rawest form seems to be taking on a new life. UCITS III (a mutual fund vehicle) is now making that absolutely (and relatively) apparent – although you would not know it with the co-habitation of the term “hedge fund” with UCITS III as in “UCITS III hedge funds.” The term “Newcits Funds” is a good start (although it will necessarily become old one day and sounded dated). For now it is what is new.
*In September 2006, an article/interview appeared in the publication “CityWire” based on the information and views in the original whitepaper.