HOW work? DO HEDGE FUNDS
Following recent changes in legislation, hedge funds are now subject to regulation in SA. This means that if you want to invest in a hedge fund, you have greater protection as an investor. But what are hedge funds? Neesa Moodley reports
Angela Costandius, Deloitte’s Cape Town-based financial services audit manager, says one of the biggest effects of the new regulation will be that South African hedge funds, which have estimated combined assets under management of R83 billion, will now be required to appoint a management company to oversee operations, in addition to their administration and asset management arms.
Collective investment schemes are required by law to have an administrator, asset manager and management company. Hedge funds were traditionally divided into an administrator and asset manager, but have until October 30 2016 to comply with new regulations, which, for one, require the appointment of a management company.
Costandius says another positive aspect of the new regulations is that individual investors will have access to a wider range of assets, such as larger limits of unlisted investments, as well as sophisticated trading strategies such as short selling. “At this stage, unit trust fund managers may not borrow money to invest, neither may they short the market.”
Leveraging, or borrowing certain instruments to trade them on financial markets, can also be used by hedge funds to take positions in certain assets without having to own them. This puts them in a rather unique position in that they don’t have to pay securities transfer tax.
Short selling involves selling a security that the seller does not yet own at an agreed price, based on the belief that the price of that security will fall below the specified price by the time the transaction actually occurs. That allows the seller to pocket the difference and make a profit.
“Hedge funds have the advantage in that they have a greater array of trading strategies available to them in order to enhance returns for their investors,” says Costandius.
“If they think a certain asset price is going to decline, they can devise a strategy to try to profit from that, whereas all a unit trust portfolio manager can really do is sell out of that asset.” Higher-risk investment
“There is obviously a bit more risk associated with these highly sophisticated trading strategies, but potential returns are higher,” says Costandius. “At the same time, hedge funds are able to be a lot more agile.”
She says the perception of hedge funds as operations run by investment “cowboys” is largely unfair, as retail funds in particular have stringent restrictions on what their asset managers can invest in, as well as limits on leveraging. Hedge fund managers are required to be licensed with the Financial Services Board and the risk within the funds is also closely monitored by the Collective Investment Schemes Control Act.
Novare Collective Investment Schemes recently launched South Africa’s first retail hedge funds, including the Novare Mayibentsha Growth Retail fund of hedge funds, which is available to individual investors.
Rene Miles, managing director of Novare Collective Investment Schemes, says the two most important benefits of including hedge funds as an additional alternative asset class in an investment portfolio are capital protection and assetclass diversification.
“South African hedge funds have been successful in protecting capital and minimising drawdowns, resulting in enhanced returns and lower risk in the overall portfolio. In terms of diversification, hedge funds respond differently to market conditions compared with traditional asset classes, resulting in a low correlation with other assets,” she says.