To vastly oversimplify, alternative funds are designed for professional and affluent investors, while Ucits funds are designed for retail investors.
Ucits stands for Undertakings for the Collective Investment in Transferable Securities. They were created by a European directive in the late 1980s, which allowed mutual funds to be based in one EU country and sold across the entire bloc. (Subsequently European Ucits have been authorised for sale in dozens of markets around the world, but notably not in the US.)
Luxembourg implemented the rules early, attracting a large number of global and regional investment firms to set up shop in the grand duchy. Today, Ucits form the backbone of the country’s financial sector, although in recent years alternative funds have been growing at a much faster clip.
While Ucits are a specific structure, ‘alternative funds’ is more of a catch-all phrase for a number of asset classes geared towards sophisticated investors.
There are big differences in what alternative and Ucits funds invest in and how they are sold to investors. Ucits are the type of investment funds that you can easily buy from your local bank or an online brokerage. They are highly regulated and considered generally safe for pretty much all investors.
Ucits are relatively affordable; an initial investment of a few hundred euros is perfectly reasonable. They are also easy to sell; fund units can normally be redeemed within a few days or within a couple of weeks at most. Management fees are fairly cheap.
On the other hand, it is harder for investors to get into and out of alternative funds. In Luxembourg, the absolute minimum investment is €100,000 or €125,000, depending on the type of investment. (The minimum is even higher in some countries, such as Germany and Switzerland.) However, many investment managers will ask for €1m or more to enter into a fund.
This makes sense for the average investor in alternative investment funds, which include the likes of pension funds, insurers, endowments and wealthy families. Their stakes are typically tied up for 3 to 15 years. While they sometimes can sell their shares on the secondary market, there is no guarantee if that can happen, how long that will take and what price it will garner.
Alternative funds invest on a longer-term horizon as well. Private equity and venture capital funds hold stakes in privately held firms for several years. Private debt funds issue loans to companies and buy company loans off lenders. Infrastructure funds and real estate funds finance long-term, big ticket investments. Returns have historically been higher, but these funds face higher risk and lower liquidity.
Alternative funds are often called private market funds. Depending on the type of fund, prices are only definitively struck for each share sale; underlying value can be less clear when stakes are simply being held. Other funds will calculate the valuation as assets are bought or sold, but that still leaves gaps in readily available data.
In comparison, there is reams of transparent pricing data for the holdings in Ucits funds, which are sometimes referred to public market funds. Ucits buy and sell shares, bonds and commodities that are traded on stock markets and other public marketplaces. Prices can be volatile and values can certainly decline, but there is nearly always a buyer when investors want to sell.
Fostering a growing market
Over the past few years, alternative funds have logged double-digit gains, “and the continued forecast is for growth in this industry,” Alan Dundon of the Luxembourg Alternative Administrators Association has said.
The grand duchy’s funds sector has been working to keep Luxembourg attractive for alternative fund firms. This includes, for example, lobbying, so far successfully, to keep a pending reform of EU rules from dampening the rapidly expanding private debt segment. And earlier this year, Luxembourg’s parliament approved legislation that enhances the use of collateralised loan obligations, a boost for private equity and private debt funds.
Next week’s jargon buster: “article 8” and “article 9” fund classifications.