Fixed Income  

UK funds dodge Esma duration-hedged ban

UK funds dodge Esma duration-hedged ban
 Esma’s ruling is expected to have only a “minor impact” on UK retail funds

Fund buyers have played down the impact of a European regulatory directive clamping down on funds that offer a duration-hedged share class as a way for investors to artificially manage duration.

Last month the European Securities and Markets Authority (Esma) issued a notice to national regulators calling for all duration-hedged share classes to be closed to new investment within six months, and to all investment by July 2018.

The ruling, which confirmed proposals made in a discussion paper last April, has been challenged by trade bodies including the European Fund and Asset Management Association and the UK’s Investment Association.

However, the impact on the UK retail marketplace is expected to be minimal. Figures from Morningstar show the vast majority of duration-hedged products available to UK investors are standalone funds – structures which are not affected by the ruling.

One large portfolio, Axa IM’s €3.9bn (£3.3bn) WF Global Inflation Bonds, does offer a duration-hedged sterling share class, but this holds just £37m in assets. The fund house also launched a standalone duration-hedged product last year “in anticipation” of Esma’s action, according to a company spokesperson.

Meena Lakshmanan, partner and head of alternatives at LGT Vestra, agreed that most wealth managers used funds rather than share classes to take a view on duration.

LGT Vestra did not have any funds with a duration-hedged share class on its buy list, she added.

Adrian Lowcock, investment director at Architas, said those who were obliged to sell out of duration-hedged share classes would be adding “a layer of admin”, which “may have a minor impact on performance”.

But he said that sophisticated investors using these share classes “can find other ways of expressing their view [on duration]”, using instruments such as derivatives, or simply via the use of a segregated mandate rather than a separate share class.

Both Mr Lowcock and Ms Lakshmanan were surprised that currency hedging had been excluded from Esma’s ruling, stating that a currency hedge could change the performance of a share class just as much as a duration hedge.

Esma’s ban was based on the idea that share classes offering the ability to hedge risks such as duration could have a significantly different risk profile and investment outcome to the ordinary fund. It argued a fund’s share classes should have a “common investment objective”.

The regulator said: “Share classes of the same fund should have a common investment objective reflected by a common pool of assets. Esma considers hedging arrangements at share class level – with the exception of currency risk hedging – are not compatible with the requirement for a fund to have a common investment objective.”