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Hedge funds should be for all

Legislation has changed, but there are still major regulatory hurdles that limit access to this asset class.
Hedge funds are no longer maverick investment products; they’re simply a different asset class that should be available to everyone. Image: Shutterstock

Unless you’re involved in the industry and have the requisite technical knowledge, you’ll probably enlist the services of an independent financial advisor to help you maximise the growth of your investments, and to structure your portfolio in a way that makes sense for your lifestyle.

The advisor is therefore a major gatekeeper to retail wealth, and they wield immense power in choosing where such wealth should be invested.

As an asset class, hedge funds can offer exceptional returns for increasingly minimal risk, but the way it stands now, the legislation makes it difficult – if not impossible – for advisors to give advice with respect to hedge funds or place their clients’ money into a hedge fund.

In the past, all hedge funds were unregulated – they could not be marketed to the general public and only institutional investors had access to them.

(The funds themselves might not have been regulated, but asset managers who operated in the hedge fund space were required to hold a special category of licence under the Financial Advisory and Intermediary Services [Fais] Act).

In 2015, however, hedge funds were declared to be a collective investment schemes, and as such they were drawn within the ambit of the Collective Investment Schemes Control Act (Cisca), becoming regulated financial products for the first time.

The new legislation classified hedge funds into two categories: qualified investor hedge funds and retail hedge funds. Hedge fund managers had been clamouring for the latter category for years, and one would have thought that the ability to market hedge funds to the general public in South Africa would have been an answer to their prayers.

In practice, however, this has not played out as expected.

Barriers to entry

The first problem concerns the relationship between hedge funds and funds of funds. A fund of funds is often the investment vehicle of choice for an advisor, but when the hedge fund legislation was updated, it wasn’t updated for funds of funds, and a fund of funds is therefore prohibited from investing in a hedge fund. This blocks at least one channel for retail investors.

Another popular option for an advisor is to invest a client’s money via a linked investment service provider (Lisp) platform, such as Momentum, Allan Gray, Sanlam Glacier or similar. There are problems for retail hedge funds on such platforms too. Only Momentum has thus far given the green light to single-manager hedge funds. But investors need to sign an additional risk-disclosure document, which immediately raises an unwarranted alarm.

Licence dilemma

The headache gets worse: despite the already slim pickings on Lisp platforms, an advisor is only allowed to place a client’s money in a hedge fund if that advisor is appropriately authorised to do so in terms of their Category 1 Fais licence.

Practically, however, very few advisors have worked in the hedge fund space and have the necessary experience – and gaining such experience after the fact is an onerous process. As a result, hardly any advisors in South Africa are authorised to render hedge fund services and provide advice in respect of hedge funds.

It’s madness. The marketing of retail hedge funds might be permitted by the legislation, but it means nothing if advisors are not permitted to do so, especially considering the barriers to entry presented by funds of funds and Lisp platforms, and there seems to be no one canvassing on behalf of hedge funds in South Africa.

Ultimately, the discourse surrounding hedge funds needs to change. Hedge funds are no longer the maverick investment products they once were; they’re simply a different asset class that should be available to everyone.

After all, additional diversification is an absolute necessity in the current low-return environment.

Read: SA hedge funds outperform Warren Buffett’s million dollar bet 

Wilhelm Landman is a director at AIP Capital Management.

COMMENTS   7

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Maybe the name creates some confusion among retail investors and their advisors. After taking an hour to explain what “hedging” means, you tell the client that the particular strategy does not include any hedging. It is simply a name without any meaning. It is called a Hedge Fund, but it does not necessarily hedge any positions. It should rather be called Alternative Strategy Funds.

The advisor should explain the particular investment strategy of the specific manager to the client. The client basically buys into the investment- and management strategy when he invests in a “hedge fund”. If a management style aims to deliver above-average performance, then the management strategy must be out of the ordinary, different, innovative, superior and easy to explain.

The Hedge Fund Manager has a powerful tool in the form of leverage or gearing to improve returns, but gearing is also a weapon of mass financial destruction. Gearing is like a radio-isotope. In the hands of a skilled oncologist, it can cure cancer, but in the wrong hands, it causes cancer.

Fees must fall before hedge funds for all.

“As an asset class, hedge funds can offer exceptional returns for increasingly minimal risk.”

You are obviously talking from the (fee) perspective of the fund manager, because it would be highly irresponsible to make such an unqualified claim to investors. It is also completely at odds with the purpose of hedge funds in a sensible diversified portfolio.

It also explains why “additional risk-disclosure documents” are required, to caution investors against people like you, making reckless promises.

You are clearly not aware that this article is marketing collateral and therefore subject to FAIS requirements. Have your compliance office read through them before you post.

Agree, I was slightly disturbed when I read this article…

Hedge funds should most definitely NOT be for all.

This is a very risky asset class.

Even some of the most sophisticated investors do not understand the risk/rewards associated with these type of investments.

The sad reality is that most people need some protection from themselves.

A dated, confusing and almost always costly asset class.

It often crosses the line between investing and gambling, i would rather invest in an index and have a full view of what i am buying with low fees .

The licensing dilemma is not correct. Hedge funds are not the exception to the rule. If an advisor was approved by the FSCA to provide advice on unit trusts before the enactment of board notice 194 (April 2018), the said advisor would be approved to provide advise on hedge funds. The advisor only had to submit forms to the FSCA, no additional experience is required. Any post board notice 194, for any category of product would require the advisor to be placed under supervision in order for that advisor to gain experience.

End of comments.

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