The face of SA hedge funds
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.”