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The cutting hedge

Chris Salih on the FSA’s welcome move to open up funds of hedge funds.

It is not often that decisions by the FSA are welcomed with open arms but last week’s proposals to allow UK retail consumers to invest in funds of hedge funds and other alternative investments sold by firms authorised in the UK have been broadly welcomed.

The proposals would see retail funds of hedge funds brought under its regulation and a number of structural and operat-ional safeguards imposed to ensure that their are sufficient controls in place and the running and marketing of the funds fits in with the regulator’s treating customers fairly principles.

There is also a recommendation that the existing investment restriction which limits non-Ucits retail schemes to holding 20 per cent in unregulated funds is scrapped.

The Alternative Investment Management Association regulatory department manager Matthew Jones says the proposal is a massive step forward as it offers investors more means to diversify their portfolios. He says: “There is a common goal shared by the industry and the FSA to optimise the investment environment for investors and we believe that this is a positive step forward.

“The FSA is right to conclude that retail investors should be given the opportunity to invest in market-leading investment products that can deliver absolute return performance in all markets, so giving a better opportunity for risk diversification.”

Charles Stanley hedge fund and structured product analyst Pryesh Emrith believes the decision not only gives investors greater choice but it also levels the playing field with institutional investors which, as bigger firms, tend to have more resources to research these vehicles.

Emrith says: “The FSA has spotted a growing private investor demand for exposure to hedge funds and alternative investments and has wisely determined that it is better for them to do so through the regulated structure of a fund of funds. It is also much safer for smaller investors for these products to be offered through FSA-regulated firms which can offer professional investment advice.

“The proposed new rules place a responsibility on the industry to educate investors about the products and how they might be used as part of an investment portfolio. It is vitally important that the industry rises to the challenge. A lot of public concern about Faifs is fear of the unknown. If it is explained to potential investors how these funds are constructed and how they might use them, I believe a lot of their concerns will be allayed.”

Despite London being a major global hub of hedge fund management, very little hedge fund money is domiciled here. The offering of these products – of which there are currently around 9,000 – will also enable London to compete for these assets, which have typically been Dublin, Luxemburg or Cayman/ Bermuda-domiciled.

HSBC Alternative Investments spokesman Jamie Murray says: “This decision will bring the UK in line with a range of different European countries, including France, Ireland, Spain and Switzerland, which have opened their markets to retail and high-net-worth investors.

“The number of hedge funds worldwide makes it impossible for the average retail investor to research individual funds, making a Fohf run by an experienced manager, with the resources to undertake extensive, ongoing research a sensible solution to this problem.”

No doubt, some firms will have to change the way they are run to meet the FSA’s required safeguards such as having an independent depository and adhering to strict rules on the independent valuation of underlying assets and timely redemption of investments.

The lifting of the 20 per cent investment restriction for Nurs funds has also been saddled with a proposal for fund manager guidance if they choose to raise or maintain significant investment into unregulated schemes.

Bramdean chief executive Nicola Horlick says the decision to impose safeguards is fundamental to ensure that the proposal is a success.

She says: “It is crucial that investors should be able to rely upon the same high standards and protection offered to them when they invests in traditional equities and bonds. It will also be important that investors are able to easily identify high-calibre advisers and investment managers who can help them make appropriate investment decisions in alternative assets.”

But there are some holes in the regulator’s proposals which are causing some consternation such as a lack of clarity around how the taxation of funds of hedge funds will work.

Threadneedle head of product development Celeste Dias says: “It needs to be sorted out quickly. This is a massive opportunity to do something proactive in the industry, with the only problem being that offshore funds are liable to income tax and cannot use capital gains tax.

We already do masses in the Fohf arena in the German market and if the tax issues are sorted out, I am sure that ourselves and a number of others would build up our activities in the UK.”


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