Increased appetite for hedge funds from SA’s investors
• There’s healthy growth in this alternative asset class, writes Lynette Dicey
As returns from traditional asset classes come under growing pressure, alternative investments are looking increasingly attractive. One alternative investment asset class that is seeing healthy growth is hedge funds.
SA’s hedge fund industry saw encouraging growth in 2021 ending the year with assets under management of R86.93bn — a R13.66bn increase compared to the previous year, according to the Association for Savings and Investment South Africa (Asisa).
This nearly 19% growth in assets was achieved in spite of further consolidation and closure of funds, which reduced the number of hedge funds from 233 at the end of 2020 to 216 at the end of 2021.
“The reduction in hedge funds is being driven by fund managers consolidating their product offerings into either qualified investor hedge fund structures or retail hedge fund structure,” says Hayden Reinders, convenor of the Asisa Hedge Fund Standing Committee.
Despite the growth, SA’s hedge fund industry remains relatively small compared to the traditional asset classes.
SA was the first country globally to implement regulation under the Collective Investment Schemes Act for hedge fund products. The regulations stipulate two categories of hedge funds: qualified investor hedge funds and retail hedge funds. The former requires a minimum investment of R1m and is open to investors with a good understanding of the investment strategies used by hedge funds — including the associated risks.
The latter is a more strictly regulated product in terms of the investments and risks it is allowed to take. Retail hedge funds are open to any investor, subject to set minimum lump sum investment amounts, often set to R50,000.
The regulations require all hedge funds to have an independent management company who, in turn, appoints a specialist hedge fund investment manager to operate within an agreed mandate and risk profile.
“The fact that hedge funds are highly regulated and are required to have a management company in place creates certainty for the investor base and is a big strength for the industry,” says Reinders.
While hedge funds have delivered good returns on average, net inflows in 2021 were just R0.59bn. Reinders points out that this needs to be balanced against net outflows of R2.45bn during 2020.
“The return to net inflows was a positive and welcome change,” he says.
The net inflows in 2021 were driven exclusively by retail hedge funds which attracted net inflows of R1.63bn while qualified investor hedge funds recorded net outflows of R1.04bn.
“The local hedge fund industry is recovering from a period of sustained outflows, primarily from institutional investors,” says Terebinth Capital MD Nomathibana Matshoba.
She says a campaign to make retail hedge funds more accessible to retail investors — via linked investor services platforms (Lisps) for example — is the main driver of growth in flows.
The investment strategies of different hedge funds will differ depending on the strategy that has been chosen.
Hedge funds are designed to mitigate the impact of market volatility on capital by applying specialist strategies within the different asset classes, explains Reinders. They are therefore typically classified according to their investment strategies: long/short equity hedge funds tend to generate most of their returns from positions in the equity market regardless of the specific strategy employed; fixed income hedge funds are portfolios that invest in instruments and derivatives that are sensitive to movements in the interest rate market; multistrategy hedge funds are portfolios that over time don’t rely on a single asset class to generate investment opportunities but rather blend a variety of different strategies and asset classes with no single asset class dominating over time; while other hedge funds are portfolios that apply strategies that don’t fit into any of the other classification groups.
According to Reinders, the most popular hedge fund strategy in SA is equity long/ short. “At the end of 2021, 56.9% of retail money and 53.5% of qualified investor money was invested in long short equity hedge funds.”
Long positions include buy, hold and sell, while short positions are taken when fund managers expect that asset prices will decrease in future.
Hedge funds are defined as an alternative asset class. Regulation 28 of the Pension Funds Act allows retirement funds to invest up to 15% of their capital in alternative asset classes, with a maximum of 10% in hedge funds. It is expected the proposed amendments to Regulation 28 will see this allowance increase.
“We’re hoping that amendments will allow hedge funds to have their own percentage allocation in pension fund portfolios instead of the allocation being included with alternative assets,” says Marthinus van der Nest, head of Amplify Investment Partners.
Another constraint on the growth of hedge funds is Board Notice 90 which prevents longonly unit trust portfolios from investing in hedge funds — even though they are also regulated as collective investments.
Amending and correcting these issues could open the door to a far broader investor base, says Matshoba.
Although the industry continues to engage with the Financial Sector Conduct Authority, it is not clear when the regulator will make the amendments, says Van der Nest.
Reinders says the regulator is expected to release a draft report for public comment soon and that the amendments to Regulation 28 will also be finalised shortly.
“Once these regulatory changes have been implemented, hedge funds will be able to operate on a more level playing field which should result in bigger inflows.”