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Short in the act

Baring Asset Management London marketing director Ian Pascal on how Ucits III has opened the door for investors to short the market

For all its faults – and there are many – we believe the Ucits III directive should be welcomed by retail investors, fund management groups and IFAs.

It is true that the seamless cross-border “passporting” of funds issued with a Ucits stamp by the regulator in the country of origin is still very much a work in progress.

National regulators have put their own interpretations on the contents of the directive and tax harmonisation across the European Union remains as far away as ever.

Yet by introducing a much wider definition of the type of fund which can be sold to retail investors, we believe the Ucits III directive has encouraged innovation in the financial services sector across Europe and retail investors are benefiting.

For one thing, for the first time, retail investors can buy domestically registered products with the ability to short the market, with the potential to make money even when share prices or bond prices decline. Under the previous regime, an investment strategy which incorporated an element of shorting could only be accessed through hedge funds which did not typically offer investors the same degree of protection as a mutual fund.

Even the best-performing fund in the North American sector has still rec- orded a cumulative loss for investors over the past three years. Just think how useful it would have been to be able to buy products with the potential not just to conserve capital but also to generate positive investment returns when markets were approaching their peaks.

Investment firms also have the regulatory framework to offer various types of guaranteed and protec-ted funds, with the potential to deliver steady positive capital gains for inves- tors and minimise the extent of any downside in the markets.

With so much to digest in the Ucits III directive and a degree of flexibility in the way that European direc- tives are interpreted at the member state level, it is unsurprising that national regulators are forming different views on what is – and is not – permissible.

Member states broadly fall into two camps – the “liberal” jurisdictions, such as Ireland, Luxemburg and arguably the UK, and the more “conservative” jurisdictions such as Germany.

Differences of interpretation mean that products which would not be app-roved in one jurisdiction can be signed off in another and once a product has been stamped by the regulator of its country of origin, an individual jurisdiction’s regulator has no right to veto the sale or marketing of a product.

In turn, this has led to an element of “jurisdiction shopping”, where a product is registered in the country with the least onerous requirements. Germany, for example, has seen an influx of products registered in Luxemburg and given Ucits III certificates which would not qualify for certification if presented for registration in Germany. Clearly, this is not a desirable state of affairs.

At the same time, the inc-reased flexibility available under Ucits III has become common knowledge among some of the more sophist- icated retail investors and their advisers.

The badge “Ucits III compliant” is creeping into use in financial ads across Europe as a marketing tool and investors should make sure that funds labelled as Ucits III really are utilising the full flexibility of the new legislation.

In the UK, we have seen the launch of a number of new absolute return bond funds, described as taking advantage of the flexibility offered by Ucits III yet capable of doing no more than preserving capital in a falling market rather than holding out the prospect of generating a positive return as more forward-thinking products already do.

The Committee of European Securities Regulators (CESR) is putting together a consultation paper to address these concerns while the Investment Management Association has very recently produced a paper on how the regis- tration process for funds can be simplified and spee-ded up across Europe in co-operation with the European Fund and Asset Management Association.

We whole-heartedly support these efforts to produce a level playing field which makes the latest investment products available to retail investors together with a proper level of protection.

In this context, it is worth noting that a number of member states have gone beyond the requirements of the directive to extend investor protection into new areas. Although the FSA has not proposed the introduction of authorised hedge funds, the new regime all-ows investment companies to launch funds which look and feel suspiciously like them, with the ability to use shorting and leverage.

As the late great Douglas Adams put it: “If it looks like a duck and quacks like a duck, we have at least to consider the possibility that we have a small aqua-tic bird of the family anatidae on our hands.”

Investors are also able to get access to funds which invest in other alternative asset classes such as property and commodities, currently outside the scope of the Ucits III directive. Funds such as these fall under the “qualified investor” category, appealing to “expert inves-tors”. In addition, the new rules provide for the introduction of limited redemption funds suitable for investment in some of the smaller, less liquid markets, different share classes for unit trusts and performance fees for retail funds.

Not all these new products will be suitable for every investor but it is only right that retail investors have the opportunity to invest in some of the more soph-isticated investment products now available, prov-ided, of course, they are suitably advised.

In many ways, that is likely to be the most significant consequence of these regulatory changes. With so many new investment options available to the consumer, the need for retail investors to seek fin-ancial advice before committing their savings is grea- ter than ever.

The onus is on investment management groups to give intermediaries clear and concise information which allows them to advise their clients properly. Otherwise it will be “nil points” all round.


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