The Financial Services Board (FSB) has approved two hedge fund collective investment schemes for South Africa’s biggest administrator of hedge funds, Investment Data Services (IDS), and the conversion of the 83 hedge funds under its wings to collective investment schemes.
This follows the FSB’s approval earlier this year of two collective investment schemes under which Novare, a hedge fund manager and investment advisory company, plans to convert the 35 hedge funds it manages to collective investment schemes.
Ian Hamilton, the chief executive of the IDS Group, says the number of hedge funds registered as collective investment schemes is likely to increase dramatically, because unit trust funds will register as these schemes and operate as what are known as “hedge funds lite”.
The approval of IDS’s and Novare’s hedge fund collective investment schemes follows the promulgation last year of regulations that brought hedge funds under the Collective Investment Schemes Control Act (Cisca).
Jurgen Boyd, the FSB’s deputy executive in charge of collective investment schemes, says that 188 hedge fund portfolios have been approved as collective investment scheme funds, 31 portfolios have been granted provisional approval and 11 applications are under consideration.
IDS is the registered management company for a number of hedge fund managers, including 36One, Absa Alternative Asset Management, Anchor Capital, Bacci, Blue Alpha, Cadiz, Clade, Fairtree, Kadd, Polar Star, Tantalum, Truffle, Skybound, Steyn Capital, Visio and Xchequer. It also provides administration services for the hedge funds managed by Coronation and Edge.
Despite obtaining the FSB’s approval, the 83 funds administered by IDS still have to go through a conversion process, which will include obtaining investors’ approval, before they can become collective investment scheme hedge funds.
All new hedge funds must be registered in terms of Cisca, but existing funds must convert to collective investment scheme funds 12 months after registering.
The regulations provide for two categories of hedge funds:
* Qualified investor hedge funds, which are available only to investors with more than R1 million to invest who can demonstrate that they have sufficient expertise to understand the risks of hedge funds, or who invest through a financial adviser who has that expertise; and
* Retail investor hedge funds (sometimes referred to as “hedge funds lite”), which have stricter controls than qualified hedge funds and are open to any investor. For example, they are permitted to borrow (gear) up to 10 percent of the fund and must pay investors withdrawals within 30 days, as opposed to three months for qualified funds.
IDS will launch retail and qualified funds on its scheme.
Hamilton expects most new unit trust funds to register as hedge fund collective investment schemes and many existing unit trust funds to convert to hedge fund collective investment schemes, because this will enable fund managers to protect their portfolios against market corrections by making greater use of hedging than is permitted for unit trusts not registered as hedge fund collective investment schemes.
Hamilton says that in Europe an increasing number of unit trust funds have registered in terms of the Undertakings for Collective Investment in Transferable Securities (Ucits 3), which allows funds to use non-traditional investment techniques to mitigate risk. Ucits 3 funds are similar to South Africa’s retail hedge funds.
Hamilton says his company’s risk management exceeds the requirements in Cisca.
IDS will not convert some of the hedge funds it administers to regulated hedge funds until the fund managers have reduced risks that IDS considers too high, Hamilton says. For example, some managers have high concentration risk as a result of being too heavily invested in one security.
Four years ago, regulation 28 of the Pension Funds Act was amended to enable pension funds to invest significant amounts in hedge funds.
WHAT IS A HEDGE FUND?
Hedge funds pool investors’ money to buy assets. They differ from unit trust funds in that they can invest in a wider range of financial instruments and can employ investment strategies that unit trusts cannot. This can increase the investment risk.
Unit trust funds can invest in cash, bonds, equities and, to a limited extent, some derivatives, which are intended to protect the portfolio when the market falls. Hedge funds largely invest in the same instruments, such as cash and listed bonds and equities, but they can use leverage and short selling, which other unit trust funds cannot do.
A key distinction between hedge funds and unit trusts is that hedge funds can invest 100 percent into cash, whereas unit trusts (unless they have a flexible investment mandate) are limited to 20 percent cash.
Most South African hedge funds use what are called long-short strategies to provide superior returns whether investment markets are rising or falling.
Buying long means buying a security (bond or share) to hold on to it in the hope that it will increase in value.
When a manager sells short, it borrows (rents) shares from another investor and sells the shares in the expectation that the share price will drop. When the price drops, the manager buys back the shares at a cheaper price to give back to the original owner, making a profit on the difference between the selling and buying prices (less the rental).