Hedge Fund Indices for Retail Investors: UCITS Eligible or Not Eligible?

34 Pages Posted: 6 Oct 2006

See all articles by Francois Lhabitant

Francois Lhabitant

Kedge Capital Fund Management; EDHEC Business School

Date Written: July 17, 2006


Hedge fund indices have grown in numbers over the recent years and made their presence widespread through a number of providers. Assets linked to hedge fund indices currently exceed $12 billion, and the debate is now focusing on whether they should be considered as eligible assets for UCITS III funds. The consequences of a positive or negative answer from regulators are extremely important. In particular, a positive answer would imply that any non-approved offshore hedge fund can be indirectly distributed to any retail investors via an UCITS III vehicle, as long as this fund belongs to a hedge fund index. The problem is that existing hedge fund indices are fundamentally different from indices of traditional assets.

In this paper, we review non-investable hedge fund indices, the various steps of their construction and the numerous performance biases that affect their returns. These biases are so important that in our view, the majority of existing hedge fund indices are not representative of the hedge fund universe - at best, they represent a biased sample of funds that have agreed to report to a database or an index provider. The case of the so-called investable hedge fund indices, which are often presented as an alternative to actively managed funds of hedge funds, is not much better. Our observations reveal that existing investable indices are less representative of the hedge fund universe and more biased than their non-investable cousins. They are, in essence, funds of hedge funds managed according to arbitrary rules and primarily designed to support high-fee tracking products.

As a result of their numerous biases, lack of representativity and/or construction, our view is that existing hedge fund indices do not fulfill the three basic criteria required to become UCITS III eligible - sufficient diversification, ability to serve as an adequate benchmark and appropriate publication. We therefore suggest excluding them from the list of UCITS III eligible assets. Of course, in the future, this position could be revised once quality hedge fund indices are available and fulfil the aforementioned three basic criteria.

Keywords: hedge funds, UCITS, regulation, indices

JEL Classification: G1, G18

Suggested Citation

Lhabitant, Francois-Serge, Hedge Fund Indices for Retail Investors: UCITS Eligible or Not Eligible? (July 17, 2006). Swiss Finance Institute Research Paper No. 06-14. Available at SSRN: https://ssrn.com/abstract=935214 or http://dx.doi.org/10.2139/ssrn.935214

Francois-Serge Lhabitant (Contact Author)

Kedge Capital Fund Management ( email )

28-30 The Parade
St Helier, JE1 1ZZ

HOME PAGE: http://www.lhabitant.net

EDHEC Business School ( email )

393 Prom. des Anglais
Nice, 06200

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