There will be some restrictions on the retail funds to protect the general public. Some funds will have a minimum investment as low as R10 000.
In the budget speech in two weeks’ time we should learn the final shape of hedge fund regulation. To date, the local R57bn industry has been housed in limited partnerships, on life balance sheets or in debenture structures. On budget day it is widely expected they will all be deemed to be collective investment schemes (falling under the same legislation as unit trusts), as the draft regulations released last year stipulated.
SA has 113 hedge funds, which had inflows of R6bn last year.
Robert Foster, who chairs the Association for Savings & Investment SA committee on hedge funds, says there will be two types of hedge funds: qualified investor funds and retail funds.
There will be some restrictions on the retail funds to protect the general public. Some funds will have a minimum investment as low as R10 000. Foster expects retail funds will have to choose between two options to limit risk. The first is a 200% gross exposure — for example, being 100% long and 100% short. The second, more commonly used in fixed income funds, will be to limit the fund’s exposure to a 20% value at risk (VAR) — a technique used to measure and quantify the level of risk in an investment portfolio. VAR takes account of historic volatility, so an Anglo American share is more risky than a long bond which, in turn, is more risky than a three-month money market instrument. VAR looks at the 10th most negative outcome over 1 000 days or the 50th most negative outcome over 1 000 days.
Qualified Investor funds are focused on institutions and the wealthy, with a minimum subscription of at least R1m. They will have more latitude in their risk management, provided they stay within their mandates.
Thabo Khojane, CE of Investec Asset Management SA, says that, provided there is appetite from financial advisers for its hedge fund capabilities, Investec will be happy to launch retail hedge funds. “But long-only funds have done spectacularly well over the past decade. Hedge funds are most popular when the market cools off.”
For five years, the long/short equity funds have returned 13.7%/year. The JSE all share index return was 15.8%.
Simon Peile, manager of the Sygnia fund of hedge funds, says while the bulk of his assets should remain where they are on the life licence, Sygnia will also launch retail CIS products to attract financial advisers who prefer dealing with unit trusts and the linked product platforms on which they sit.
“Most of the funds in which we invest work within the proposed retail risk limits already.”
Specialist hedge funds of funds will be able to invest in retail hedge funds, but under the new regulations conventional unit trust funds of funds will not be permitted to invest in retail hedge funds.
Fairtree Capital CE Bradley Anthony expects to convert his funds into retail funds, unless they are already closed to new business such as the market-neutral fund and fixed income funds.
“We are expecting onerous reporting requirements, which will be tough for many of our competitors to comply with.”
Kim Hubner, a director of Laurium Capital, says its long/short and market-neutral funds qualify as retail funds under the new rules, but its aggressive fund takes higher risk and would remain a qualified investor fund.
“We don’t expect big demand overnight. It will be an educational process in which financial advisers will play a crucial role. But as the regulations have been delayed and delayed I don’t think advisers have given much thought to hedge funds yet.”
Foster says the public can take comfort that hedge fund managers are regulated as Category 2A licence holders under the Financial Advisory & Intermediary Services Act. And hedge fund exposure for pension funds is regulated under regulation 28 of the Pension Funds Act at a maximum of 10% of assets.
John Gilchrist, co-head of Old Mutual Customised Solutions, says there is a perception that hedge funds are high-risk and high-return, “but it will be a much better decision for managers to stick to offering inflation plus, say, 5%, which would be attractive and sustainable.”
Many hedge fund managers are hoping to see some tax clarity with the new regulations. Unit trusts by convention, but not by statute, are not taxed on trades or even from profit from derivatives. Some hedge fund managers are reluctant to expand into the retail market without clear tax exemption on all income and capital gains, instead preferring to focus on institutions such as pension funds, which are tax exempt. This is the elephant in the room which no-one in the industry will discuss on the record. It seems unlikely that national treasury will feel like being generous to hedge funds, which are considered elitist institutions though most of their clients are “un-elitist” pension funds. After the dust has started to settle, what has emerged is a picture of a company with a simplistic business model of borrowing from any source at any price, to lend that money on, on an unsecured basis and with what appears to be little in the form of credit risk assessment controls. How that fact eluded the vast majority of active asset managers in South Africa remains a mystery.