With hedge funds slowly starting to make their way onto investment platforms, the general South African public can now invest in hedge funds — for the first time ever.

Previously, only high net worth individuals and qualified investors were able to invest in hedge funds. However, the 2015 amendments to the Collective Investment Schemes Control Act, allow for hedge funds to be included under collective investment schemes (CIS) that allow individuals, regardless of net worth, to invest. Furthermore, the CIS regulator released Board Notice 52 (BN52) detailing additional compliance requirements for hedge fund managers. The aim of this regulation is to regulate and manage risk within the industry.

Despite the change in legislation, South African investors have up to now not been making good use of hedge funds as an investment vehicle. Under Regulation 28, pension funds are allowed to invest up to 10% in hedge funds. With the hedge fund market now being better regulated, it is hoped that more pension funds will make use of it as an investment vehicle.

The negative perception around hedge funds is rooted in American markets, which have a far greater risk appetite and often take big risks in the pursuit of alpha. In contrast, South African hedge fund managers place higher importance on capital protection, enabling hedge funds to limit losses during bear markets. The BN52 regulations limit managers at a 200% gross exposure, 20% one-month Historical Value-at-Risk (HVAR) and single positions are effectively limited to 30% exposure. These are only some of many limitations faced by hedge fund managers as a result of the BN52 regulations that aim to increase transparency and reduce risk.

With two main strategies, there is a hedge fund suitable for every risk profile. With the long/short strategy — the most popular in the industry — managers purchase stocks that are thought to increase in value, and short sell stocks that will decrease in value. In most cases, the manager will then add leverage to amplify performance. The extent to which the manager adds leverage will determine the risk associated with the fund. The downside during bull markets is that the short book puts considerable drag on performance. However, in bear markets and highly volatile markets, hedge funds tend to produce consistent returns with lower volatility than their long only counterparts.

On the other hand, the market neutral strategy follows a similar approach to the long/short, but aims to hedge out exposure to the market. This is most commonly done through the use of pair trades where a long and short position of similar size is taken in the same industry. As a result, general market news tends not to affect the funds as dramatically, offering clients a product with very low beta and volatility.

The South African retail hedge fund market offers investors a wide suite of products, which is well-regulated, easily investable and offers the ability to protect capital in the event of a market correction. Definitely something to consider in this uncertain investment time we find ourselves in.

 

-Nikolaas Delport

Senior Analyst, RisCura

 

 

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