Johannesburg - Hedge funds in South Africa are counting on new regulations imposed by the government to help them win credibility with pension fund managers who oversee R2.5trn.
The rules enhance oversight of hedge funds by requiring a separate management company, administrator and trustees that check and balance each other. Managers must report holdings each quarter to investors and the Financial Services Board (FSB).
It’s a move that may shoot down the industry’s “cowboy image” and unlock more of the one tenth of pension fund investments that can be allocated into hedge funds, industry insiders said.
“That 10% can be a substantial amount of money given the assets under management in the pensions industry,” Udesh Naicker, FSB head of hedge fund regulation said in an interview in Pretoria in August. “The hedge fund industry will probably experience significant growth through pension fund allocations.’’
Hedge funds sometimes use short-selling, borrowing and derivatives in addition to traditional stock picking. Some hedge fund investing strategies that take on risk by borrowing to fund bets on market directions have hurt the industry’s reputation, said Philippa Owen, chief operating officer of Tower Capital Management.
“These are generally the types of strategies that have been linked to a cowboy image globally and are unfortunately the ones that make the headlines when the bets go wrong,” she said in an email from Johannesburg. Sharing the same rules as traditional funds on how they report activity and sell themselves “will certainly help pension funds and other investors gain more confidence in hedge funds”, she said.
The attitude of South African hedge funds to increased regulation echoes the experience in the US, where in 2011 funds embraced Securities and Exchange Commission supervision as investors sought regulated venues for their money in the wake of the financial crisis.
In South Africa, despite robust investment processes, asset segregation and infrastructure, “the industry has been tainted by perceptions of rogue traders, sub-standard infrastructure and the gun-slinging cowboy caricature”, Bradley Anthony, chief investment officer at Fairtree Capital in Cape Town, said by email.
“For this reason, the vast majority of South African hedge fund managers not only welcome the regulation, but have actively participated in the processes which contributed to its introduction.”
The regulations should also increase protection of South African investors against fraud. The Relative Value Arbitrage Fund sold itself as a hedge fund in a R2.2bn ponzi scheme with about 3 000 investors that collapsed in 2012. In July of that year, under investigation by authorities and unable to keep pace with customer withdrawals, Herman Pretorius, who ran the fund, killed his former business partner Julian Williams and shot himself.
“The South African regulator is far more rigorous in its licensing of hedge funds than in the US and UK,’’ Andre Steyn, chief executive officer of Steyn Capital Management in Cape Town, said by email. Steyn, who worked on hedge funds in both those countries, controls R2bn in hedge funds and R5bn in long-only funds.
The new rules, which change hedge funds’ classification to what is termed “collective investment schemes”, are already winning over some investors. Liberty Life Insurance, which administers R220bn in corporate and individual retirement funds, will use hedge funds because the clarity and certainty of the new regulations make investors comfortable, Justin Roffey, the company’s head of portfolio construction, said in a phone interview from Johannesburg.
“It’s a ‘what-I see-on-the-can-is-what-I-get’ kind of approach,” Roffey said. “Hedge funds have a great place because of their natural tendency toward low volatility and they produce bond-like returns, so it means we have another way of creating a benefit.”
Liberty Life began trial investments in hedge funds using its own balance sheet more than five years ago and will also start investing retirement funds it administers, a move Roffey predicts will be followed by industry peers.
South African hedge funds had about R62bn under management in 111 vehicles as of June 30, according to Novare Investments, a Cape Town-based investment adviser.
The country’s collective investment scheme industry managed assets of R1.8trn across 1 225 portfolios as of June 30, according to the Association for Savings and Investment South Africa. It’s too early to determine how much would flow across to hedge funds, said Eugene Visagie, a spokesperson for Novare, and Marilyn Ramplin, director of the Hedge Fund Academy in Johannesburg.
The local industry has followed a global trend of cutting fees from about 2% of assets under management plus 20% of profits, to 1% of assets and 20% of profits, Ramplin said. While the new regulations may mean higher costs for funds, Tower Capital won’t be increasing its fees, Owen said.
The new regulations require that funds be overseen by a management company - a “manco” in industry parlance. Funds must be classified either in a new category of retail, known as RIHFs, for man-in-the street depositors, or as QIHFs for qualified investors required to invest at least R1m. Retail managers can set their own initial amounts.
Fund management companies will have 12 months after their structure is approved by the regulator to implement the changes from the old regulation. “It was considered the Wild West because it was unregulated and there was that feeling that the guys could do theoretically whatever the heck they wanted,’’ George Herman, head of South African portfolios at Citadel Wealth Management, said by phone in Johannesburg.
“We’re excited about the new regulation. We think it’s a new phase.”