The face of SA hedge funds

Finweek English Edition - - INSIGHT - BY PA­TRICK CAIRNS

The global hedge fund in­dus­try man­ages over $2.3tr in as­sets. How­ever, South Africa makes up only a tiny por­tion of that, with just R53bn ($4.8bn) in­vested in lo­cal hedge funds.

The lo­cal in­dus­try is also dwarfed by the R1.6tr un­der man­age­ment in South African unit trusts and ex­change-traded funds.

Some would say this is a good thing. There is a fairly wide­spread belief that hedge funds are lit­tle more than a way for fund man­agers to earn ex­or­bi­tant fees while of­fer­ing noth­ing par­tic­u­larly im­pres­sive by way of re­turns, and are best ig­nored al­to­gether.

How­ever, there is an op­pos­ing view that says that hedge funds are heav­ily un­der­utilised in SA. Even though the most re­cent change to Reg­u­la­tion 28 al­lows for pen­sion funds to invest up to 10% of their as­sets in hedge funds, few

come any­where close to that al­lo­ca­tion.

MIS­UN­DER­STAND­ING THE RISK

In­dus­try in­sid­ers ar­gue that hedge funds are largely mis­un­der­stood in SA. Lo­cal per­cep­tions tend to be in­formed by what takes place in­ter­na­tion­ally, par­tic­u­larly the US, where hedge funds come in any num­ber of con­vo­luted forms.

How­ever, the lo­cal in­dus­try is quite dif­fer­ent, and the belief that hedge funds are volatile, ex­pen­sive and highly lever­aged is not nec­es­sar­ily ac­cu­rate here.

“There’s a mas­sive dif­fer­ence be­tween the global ex­pe­ri­ence and the lo­cal ex­pe­ri­ence when it comes to hedge funds,” says Al­brecht Gantz, head of Ris­Cura An­a­lyt­ics. “Hedge funds are ac­tu­ally man­aged very con­ser­va­tively in South Africa.”

His view is sup­ported by Fa­tima Vawda, the man­ag­ing di­rec­tor of fund-of-funds man­ager 27Four. She says that the lo­cal mar­ket is a lot more vanilla than those off­shore, as the size of the mar­ket means that there are far fewer strate­gies that can be im­ple­mented here.

“Eq­uity long/short is the dom­i­nant strat­egy in South Africa,” she says. “Some hedge funds may do one or two other things through the use of de­riv­a­tives and in­dex fu­tures, but it’s noth­ing like what you see in the US. The very good man­agers here are all eq­uity long/short and it’s re­ally about how they utilise their net and gross ex­po­sure lev­els to gen­er­ate value.”

Ac­cord­ing to the lat­est No­vare Hedge Fund Survey, long/short eq­uity strate­gies make up 59.9% of the lo­cal in­dus­try.

Another rea­son for the per­cep­tion that hedge funds are high risk is their use of lever­age. How­ever, the lo­cal in­dus­try doesn’t use ex­ces­sive lever­age and is there­fore gen­er­ally more sta­ble.

So when ad­dress­ing the risk as­so­ci­ated

with lo­cal hedge f unds, t he more im­por­tant ques­tions are re­ally about what kind of ex­po­sures you are get­ting.

“You have to def ine what risk is be­cause you could say that, cur­rently, be­ing in­vested in a long-only eq­uity fund is a risky in­vest­ment,” 27Four’s Vawda says. “Whereas if you are in­vested in a hedge fund that is short some of the over­priced stocks, that could be quite a con­ser­va­tive strat­egy given where we are in the mar­ket.”

This is borne out some­what by the way South African hedge funds stood up in the 2008 mar­ket crash.

“In 2008 if you were a long-only in­vestor there was no place to hide, but the South African hedge fund mar­ket was net pos­i­tive on per­for­mance for that year,” Gantz says. “So it can of­fer cap­i­tal pro­tec­tion.”

THE RE­TAIL QUES­TION

Un­til now, hedge funds in SA have been ex­clu­sively used by in­sti­tu­tional in­vestors. How­ever, new reg­u­la­tions due to be in­tro­duced next year will cre­ate a cat­e­gory for hedge funds un­der the Col­lec­tive In­vest­ment Schemes Con­trol Act (CISCA) that will make them ac­ces­si­ble to re­tail clients.

The think­ing is that re­tail hedge funds will be sub­ject to more rig­or­ous reg­u­la­tion to pro­tect in­vestors. How­ever, both Vawda and Gantz ar­gue that be­cause of the con­ser­va­tive na­ture of the lo­cal in­dus­try, the majority of funds al­ready meet th­ese re­quire­ments.

“Prob­a­bly 80% to 85% of man­agers al­ready fall within scope of the re­tail lim­its set by the reg­u­la­tor be­cause our man­agers are not at that level of risk,” says Gantz.

He be­lieves that self-reg­u­la­tion also has a large part to play in this. While gov­er­nance of hedge funds has been a big prob­lem off­shore, it has not been so here.

“For ex­am­ple, we can see the daily hold­ings and daily trades of all the clients we run re­ports on,” he says. “At month- end we can do a f ul l rec­on­cil­i­a­tion be­tween bro­ker data and ad­min­is­tra­tor data to make sure that ev­ery­one is on the same page. So there’s no op­por­tu­nity for fund man­agers to fid­dle with their re­turns.”

One area where the in­dus­try may have to do some in­tro­spec­tion, how­ever, is its fee struc­tures. “I do think that man­agers need to be cog­nisant of their fees,” Vawda says. “A lot of hedge fund man­agers have zero idea of what long-only man­agers are charg­ing and when you tell them, they think it’s not pos­si­ble.”

If man­agers are to at­tract re­tail as­sets, Vawda be­lieves that they will have to think of cap­ping fees and us­ing ap­pro­pri­ate hur­dle rates that are re­lated to some form of bench­mark rather than a sim­ple ab­so­lute re­turn.

But over­all, re­tail clients should be conf ident that lo­cal hedge f und in­vest­ments are not some­thing madly risky. “Although in the US hedge funds are of­ten sold as a dif­fer­ent as­set class, in South Africa they are def­i­nitely still sold as eq­ui­ties, bonds and cash, just with vari­ant strate­gies,” says Ris­Cura’s Gantz. “Here funds are much more cog­nisant of risk and cap­i­tal pro­tec­tion. It’s not about swing­ing for the fences.”

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