The often controversial hedge fund industry, mainly on the back of greater retirement fund investment, grew by R5.1 billion last year, ending the year with assets under management of R62.1 billion.
This is a mere fraction of the almost R2 trillion that the collective investment industry has under management.
Robert Foster, convenor of the Association for Savings & Investment SA (Asisa) hedge funds standing committee, says the hedge fund industry has enjoyed a steady growth in assets in recent years since retirement funds were allowed to invest a portion of their assets in hedge funds in 2011.
And Foster says another growth spurt can be expected now that hedge funds have become regulated for the first time.
He says the first two hedge fund management companies and their funds, representing about 70 percent of the industry’s assets under management, were approved by the Financial Services Board (FSB) in December in terms of a Collective Investment Schemes Control Act (Cisca) regulation that requires hedge funds to register as collective investment schemes. Once a fund is registered, it has 12 months to comply with all aspects of the regulation.
However, the FSB deputy registrar of pensions, Rosemary Hunter, is seeking to toughen up the conditions under which retirement funds can invest in hedge funds beyond what is provided for in Cisca. She has proposed new conditions for hedge fund investment by retirement funds by way of an amendment to the prudential investment guidelines for retirement funds in regulation 28 of the Pension Funds Act.
Currently, regulation 28 limits how much may be invested by a retirement fund in a hedge fund to only 10 percent of its assets. There is currently no stipulation that they must invest in regulated hedge funds.
The Cisca regulations provide for hedge funds to be classified in two broad categories:
* Qualified investor hedge funds (Qihfs), which are available only to institutional investors, such as retirement funds, and financially sophisticated individuals; and
* Retail investor hedge funds (Rihfs), which are open to ordinary investors, but can have fairly high minimum investment amounts. They are more strictly regulated than Qihfs and cannot take as many investment risks.
Foster says the primary difference between Qihfs and Rihfs is the size of the positions they can take in any one financial security and how much may borrow to increase exposure one or more financial securities, multiplying the potential for profits and losses (the leverage limits). For Qihfs the mandates are wider but still need FSB approval.
He says the proposed changes to regulation 28 controls on hedge funds will mean that retirement funds will be allowed to invest only in Rihfs.
The move has come in for strong criticism from Ian Hamilton, the head of IDS Fund Services, the largest hedge-fund administration company in South Africa. Hamilton says the FSB’s proposed measures will result in a bureaucratic muddle and possibly in retirement funds deriving inferior performance from hedge-fund investments.
However, Foster says that if the proposed regulation 28 changes are adopted unchallenged, it would not be a problem for the industry. “Currently, portfolios controlling about 70 percent of hedge fund assets would be available for retirement fund investment without changing their mandates.
“The issue is more that retirement funds internationally and locally are regarded as qualified investors and have more than enough access to resources to suitably assess the potential risks of any investment they make and should therefore not be dictated to regarding this assessment capability.”
Foster says the reason for the provision in Cisca for retail hedge funds was to provide ordinary investors with access to investment skills previously only accessible to investors with large amounts to invest. The local industry agreed to the retail fund mandate limits knowing that 70 percent of assets managed by hedge funds would not have to be changed but would become accessible to smaller investors seeking to use hedge fund managers.
Hamilton says he feels hedge fund investment should be limited to institutional investors, such as retirement funds and wealthy individuals, and there should not be a retail offering for smaller investors, because they have insufficient knowledge.
Foster says hedge funds aim to reduce market volatility for investors by applying specialist strategies and should be considered as one of the building blocks of a well-diversified investment portfolio. Hedge funds apply a number of different strategies to mitigate the impact of market volatility. The most common strategy in South Africa is referred to as “equity long/short”. At the end of last year, some 61 percent of hedge fund assets were invested using this type of strategy.
He says the bulk of hedge fund assets are invested in “sizeable portfolios managed by well-established hedge fund asset managers with a consistent track record of success.”
Foster says the HedgeNews Africa Long/Short Equity Index delivered a performance of 17.1 percent for the year to the end of 2015, 15.1 percent over five years and 14.5 percent over seven years.
By comparison, the FTSE/JSE All Share Index (Alsi) achieved 5.1 percent for the 12 months to the end of 2015, 13 percent over five years and 16.4 percent over seven years.
The SA Multi Asset Medium Equity category of collective investment schemes recorded average returns of 7.4 percent for the year to the end of 2015, 10.6 percent over five years and 11.3 percent for seven years.
Foster says these performance figures illustrate the role of hedge funds in a well-diversified investment portfolio.
“Hedge funds are designed to outperform the markets during times of extreme volatility as experienced last year. However, when financial markets deliver strong performance, hedge funds are unlikely to shoot the lights out.”
“A common misperception is that hedge funds are an asset class. Hedge funds are not an asset class. Instead they manage asset classes such as equities, bonds, cash and property by applying specialist strategies such as equity long/short, fixed-interest arbitrage and multi-strategy to protect against losses.”
The intention is not to make extraordinary profits, Foster says.