So-called “hedge fund lite” products that have grown increasingly popular due to their ability to take short positions but under a regulatory umbrella may nevertheless carry risks, Collins Stewart Fund Management says.

UCITS III funds, which are structures enabled by European Union rules in the noughties, allow managers to use derivatives to take short, as well as long, market positions – a freedom once the sole preserve of hedge funds. UCITS funds are regulated and offer high levels of liquidity, which is attractive to investors fearful of being unable to withdraw money from a hedge fund, as happened when funds shut the exits amid the credit crisis over a year ago.

However, it would be an error for investors to assume that UCITS III funds are risk-free and without dangers for the unwary, according to Mike Brown, head of funds at the UK business, which is part of wealth manager and broker Collins Stewart. He said he endorsed recent concerns made by the Financial Services Authority on the issue.

“There are undoubtedly risks within UCITS III funds that the market may not have fully appreciated,” he told WealthBriefing in a telephone interview.

“In discussions with our clients, I get the feeling that people might be in danger of over-simplying what can be a complex product structure, although not all of them are complicated,” he said. “There are risks of people not fully understanding the implications of the freedoms that UCITS III funds have, such as in having the ability to short.”

Mr Brown’s own firm has an example of a UCITS III absolute return product of its own, such as its Alternative Strategies Fund, which was launched in October 2009; it is a fund of funds.

One key test of such products is whether they can hold value when markets are falling. In 2008, when broad equity market indices fell by around 40 per cent, according to MSCI, the CSFM fund lost just 0.62 per cent net of fees in sterling terms. This fund of funds is a Dublin-based UCITS III vehicle.

The FSA recently warned about the problems associated with a rush into UCITS III products. Dan Waters, director, conduct risk, and asset management sector leader, talked about what he saw as a “UCITS III bandwagon”.

“We would remind new UCITS managers that compliance with the UCITS framework will take considerable investment in systems and controls, and while asset managers may delegate various functions, they retain ultimate responsibility for compliance with the quite detailed requirements of UCITS III and, even more, under UCITS IV,” he said in a speech on 25 January.