LONDON (Reuters) - Retail investors are pulling out of Europe's hedge fund industry, with assets under management shrinking to an eight-year low according to data released on Monday, as higher interest rates and lagging performance send smaller investors elsewhere.

Assets in alternative 'UCITS' funds in Europe shrank 3% to $236.3 billion at the end of March from three months earlier, according to research provider Kepler Absolute Hedge, which has data going back to 2016. The drop was faster than the 0.4% decline seen in the previous two quarters, Kepler said.

UCITS, or undertakings for collective investment in transferable securities, are a type of fund sold in the European Union which are heavily regulated to make them safer and more accessible to the public.

While UCITS have proved popular overall - accounting for 12 trillion euros ($12.9 trillion) of assets at end-2022, according to industry data - they have fallen out of favour with investors chasing higher returns.

"Hedge fund UCITS are rightly getting a lot of flak from investors lately. In fact, they increasingly strike me as an ice cube sitting in the sun," said Harald Berlinicke, partner at Sarnia Asset Management.

"As many investors have found out the hard way, handcuffing hedge fund managers by imposing tighter restrictions...may have defeated the purpose."

UCITS funds place restrictions on the leverage and risk-taking that enable other funds bought by institutional investors to juice up their returns.

In the first three months of 2024, UCITS funds tracked by Kepler averaged a 2.9% return compared with the 4.4% averaged by the wider hedge fund industry, according to research firm HFR.

Overall assets fell by $7.6 billion from alternative UCITS funds in the first quarter, mostly from multi-strategy, macro-economic and deals focused funds, while some hedge fund strategies like managed futures saw growth, Kepler's report showed.

Swiss private bank Julius Baer has been pulling client funds from UCITS hedge funds, according to a January client note seen by Reuters in which Chief Investment Officer Yves Bonzo cited poor returns and high fees, adding that offshore rivals had "systematically outperformed" them.

Julius Baer declined to comment.

Private equity giant Blackstone closed its multi-strategy UCITS fund in November, after assets fell nearly 90% in four years.

($1 = 0.9295 euros)