(April 4, 2013) — Hedge funds wrapped in a supposedly structure have inflicted higher volatility and tail risk on their owners, while underperforming their mainstream rivals, research has found.
Following the revelation of the Madoff scandal, many hedge fund managers were convinced to offer investors vehicles that were compliant with the stringent Ucits wrapper to boost confidence in the sector.
Products using this wrapper were forbidden from using certain financial instruments, including a wide range of derivatives, and were, above all, intended to be very liquid.
But these features have been the funds’ undoing, according to the Edhec Risk Institute. Ucits wrapped hedge funds offer more volatility and tail risk than their mainstream counterparts – and crucially, they underperform.
Risk management techniques used in hedge funds that are forbidden in Ucits products help to dampen volatility, the report said.
“Overall average performance results… show that hedge funds seem to outperform Ucits hedge funds,” the report said. “Consistently across time-periods and portfolio weighing schemes, standard performance measures are higher for HFs even after accounting for tail risk.”
In addition, the report found systematic risk exposure was higher for Ucits hedge funds than traditional rival funds.
One plus for investors in the Ucits vehicle is the relatively lower fees, the report said, but due to these products being of a smaller size, they are likely to suffer a performance drag resulting from the total expense ratio.
Looking at the Sharpe Ratio, which measures the reward earned for risk taken, both sets of funds outperformed equity markets.
Despite investors initially showing interest in the products, research from data monitor Pertac showed assets under management for Ucits hedge funds peaked in May 2011.
At the end of 2011, assets under management were €120 billion, having quadrupled since March 2009, but the sector’s popularity has not matched that of traditional hedge funds.
To read the full Edhec report, click here.