SA Hedge Funds at the crossroads

Hedge funds in South Africa are at the crossroads. The second draft of Regulation 28 to the Pension Funds Act is expected soon and it is foreseen that this will either allow the industry to flourish or simply gradually bleed to death.

The industry, which is presently valued at R30-billion and served by some 70 hedge fund management firms, is currently experiencing a minimal inflow of investments. This is in part because no clearly demarcated arena in the investment spectrum of especially pension funds is allocated to the hedge fund industry.

Approximately 70% of assets in the industry hail from only a few specific pension funds. In terms of the prudent investment guidelines applicable to Regulation 28, it is apparent that hedge funds are forced to compete in the same arena with private equity investments that comprises of an asset allocation of only 2,5%.

While stocks, the money market and property have their own investment classification, hedge funds are simply classified by the financial authorities as “other” – a situation that further erodes the industry’s status.

Head of PSG Absolute Investments, Jean-Pierre Matthews, says that strictly speaking this results in pension funds finding it difficult to invest more than 2,5% of their assets in hedge funds and hence to a degree find it not worth the effort.

The National Treasury has however in the 2010-budget initiated a process to update Regulation 28 to the Pension Funds Act after its last adjustment in 1998. The first version of the draft regulations concerning the relevant legislation flowed from this, which broadly determined that hedge funds should remain with private equities within the 2,5% inclusion limit.

“This has practically forced the industry to a standstill. There is however hope that a better dispensation will emerge from the second version of the draft regulations.

“Nevertheless, there remains a good relationship between the hedge fund industry, the National Treasury and the Financial Services Board (FSB). The hedge fund industry welcomes additional regulation and co-operates willingly with regulators to establish a world class governance framework.

“The FSB already regulates hedge fund managers through a special FSP 2A licence, which is only issued to suitable and qualified managers with the required infrastructure and experience. It is seen as an important step in the right direction, and a very progressive piece of regulation – even by global standards.

“The problem however is that Regulation 28 does not allow enough investment flow for the industry to be viable and to add value to pension fund investments and the investment community in general,” says Matthews.

According to finance minister Pravin Gordhan’s recent medium-term budget policy statement, the second draft seeks to ensure:

· That the regulatory response is proportionate to the specific risks identified;

· That asset categories with the same risks should have similar or equivalent limits;

· Investments in riskier assets should not be banned outright, but the risk should be mitigated; and

· The true nature of the asset should be reported.

Matthews says the aforementioned resolutions do create hope that the hedge fund industry will now be able to take its rightful place in the investment spectrum. The worst scenario for the hedge fund industry would be if the status quo remains.