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Hedge funds cannot be ignored in volatile markets

FSB approves first retail hedge fund under CISCA.

JOHANNESBURG – As the first retail hedge fund gets to the go ahead from the Financial Services Board (FSB) – with many more lining up for the same stamp of approval – Eugene Visagie, head of hedge fund investments at Novare Investments, says that institutional investors cannot continue to ignore hedge funds any longer. This is particularly where they have reached the Regulation 28-enforced cap on offshore assets and at a time when local equities offer few opportunities.

As of April 1, hedge funds were declared collective investment schemes (CIS) and now fall under the Collective Investment Schemes Control Act (CISCA). The FSB on Friday announced that it has approved the first hedge fund under CISCA and said it is considering 20 other applications from management companies wanting to register such funds.

Both of the approved schemes – one a Qualified Investor Hedge Fund (QIHF) and the other a Retail Investor Hedge Fund (RIHF) – are registered under the Novare Collective Investments management company.

“This represents a milestone in the CIS industry as this is the first time that a regulated hedge fund will be marketed as a product offering,” the FSB said in a statement.

It said that the 20 applications it is considering comprise 17 QIHFs (open only to more sophisticated investors) and 13 RIHFs (open to the general public and subject to more stringent regulation).

Together they represent in excess of R95 billion in assets under management (AUM), which includes fund of hedge fund assets (i.e. funds holding a portfolio of hedge funds).

Now that they fall under CISCA regulation, Visagie believes there is significant opportunity to market hedge funds to institutional investors. “Pension fund trustees are very wary of investing in unregulated instruments, but new regulations mean that hedge funds are effectively unit trusts with a different way of extracting alpha from the market,” he comments.

At June 2015, the local CIS industry-managed assets of R1.8 trillion, offering investors 1 225 portfolios. Institutional fund assets, including pension and provident funds, held R944 billion in assets.

“Even a 10% allocation from institutional investors would make a significant difference to hedge funds,” says Visagie, noting that Novare has seen significant interest from independent financial advisors (IFA) and brokers on the look out for something different to offer clients.

MD of Caveo Fund Solutions, Byron Green says that advisors have inherent concerns about current market valuations, which could lead them to seek yield for their clients from hedge funds.

Gyongi King, chief investment officer at Caveo, believes that retail hedge funds will appeal to medium wealth individuals, due to the capital protection with upside that they provide. She says that most hedge fund products in South Africa are fairly ‘vanilla’ and unlike those offered in much larger markets, such as the US, where risks may be higher.

King doesn’t necessarily anticipate a flood of investors into retail hedge funds, suggesting it will take time for the asset class to gain traction.

Focus on fees

While retail investors will serve to drive down fees, King says that hedge fund fees will never be as competitive as equity unit trusts. “The key is understanding what you’re paying for and what you should expect from your fund on that basis,” she explains.

That hedge funds will need to provide a fund factsheet with full disclosure and a total expense ratio (TER) will go some way in helping advisors assess the net return of the fund and whether the risk/return metric makes sense for their client, she says.

Visagie highlights that hedge funds must outperform an absolute benchmark to attract performance fees, contending that they have a higher watermark than some unit trusts. “Many unit trusts have relative benchmarks, which can result in a situation where clients actually make negative real returns but the unit trust still charges performance fees because it outperformed a benchmark that had fallen,” he explains.

Green describes hedge funds as the “horse that runs second almost all the time” from an asset class perspective. “When markets are running, hedge funds will never outperform equities, but they are likely to beat bonds. Where equity markets pull back significantly, hedge funds should provide downside protection and beat equities even if they don’t outperform bonds,” he says.

“In the current stock market environment, I think there will be scope for a high quality fund manager that uses proper hedging to manage downside risk, but at reasonable fees and with an element of transparency,” says Warren Ingram, executive director at Galileo Capital.

“Heightened volatility in the local financial market supports an allocation to hedge funds, which focus on capital preservation,” says Visagie.

 

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