The impact of Regulation 28 on the domestic hedge fund industry
South Africa’s retirement industry is governed by the Pension Funds Act, No 24 of 1956. In terms of this Act the Minister of Finance has sweeping powers to make regulations to limit the amount and extent to which pension funds may invest in certain asset
At the time Treasury observed: “The aim of retirement fund investment regulation is to ensure that the savings South Africans contribute towards their retirement is invested in a prudent manner that not only protects the retirement fund member, but is channelled in ways that achieve economic development and growth”. How was this noble goal achieved? The first point is that Regulation 28 better recognises and promotes the responsibility of funds and boards of trustees toward sound retirement fund investments. It also expands the allowance for debt issued by listed or regulated entities and better enables investments into unlisted and alternative assets to support economic development. The alternative assets angle – combined with changes to the maximum exposure funds could have to private equity and hedge funds – was welcomed by hedge fund managers countrywide.
A sensible intervention
In April 2011 I observed that hedge fund managers were extremely chuffed with the recognition Regulation 28 afforded them. They – along with other stakeholders in the financial services industry – agreed that the definition of private equity and hedge funds was long overdue. The legislation now clearly defines private equity and hedge funds and prevents large institutions from using so-called linking structures such as debentures issued against private equity fund cash flows to “hide” their hedge fund investments. How much pension fund capital should be tucked away in such assets? Treasury decided to impose a 15% limit with strict conditions.
Regulation 28 governs investments into other assets and alternative investments as follows: The total allocation to hedge funds, private equity investments and any other investment not mentioned in the regulation is 15%. However – funds may not invest more than 10% in hedge funds or private equity – and the upper cap for “other” investments is 2.5%. The maximum allocation to a single hedge fund (or private equity investment) is further limited to 2.5% with a 5% maximum for fund of hedge funds (or fund of private equity funds).
More than a year since Regulation28 went “live” we have an opportunity to assess its impact. What better way to do so than to unpack the Novare ® Investments South African Hedge Fund Survey 2012. (The survey – in its 9th year – provides an industry snapshot at 30 June 2012 as well as commentary on industry trends observed over the preceding 12 months. The survey was completed based on responses from 62 fund managers who manage in excess of 106 different mandated hedge funds).
An important consideration is that the 12 months covered in the survey were extraordinary both in terms of volatile international markets and unprecedented financial services regulation. “Despite an ever changing landscape, the industry continued to mature and even managed to position itself ahead of international peers with regard to certain pertinent aspects of best practice,” observes the survey.
The frontline of the South African hedge fund industry
Industry assets under management surged to a record high R33.6 billion midway through 2012, some 6.8% ahead of the June 2011 number. The survey found that there was a continued shift toward asset managers with larger hedge fund asset bases, with the result that managers exceeding R2 billion in fund assets now account for 46.2% of industry assets. That is not to say that new and smaller hedge fund managers were cut out of the market. Approximately R1.5 billion in net inflows went to funds with between R1 billion and R2 billion under management.
Did the softening of limits introduced by Regulation 28 result in a deluge of pension fund cash into this asset class? It is difficult to say… However, Novare observes that assets under management are just 10.9% higher than in June 2008, with a 6.8% growth since June last year. At first glance the 6.8% growth suggests an influx of funds thanks to the new regulation. This is easily disproved: “The increase in assets came mainly from participating funds’ performance over the past year rather than capital flows,” states the report. In fact the industry reported a rather disappointing net cash inflow of just R461 million. (The situation is even worse when capital returns to investors due to funds being wound up are factored in).
To finally dispel the “Regulation 28 will benefit hedge funds” myth we consider the industry investor profile. Approximately 66.3% of hedge fund assets are held by funds-of-funds with just 5.8% held by pension funds. The survey concludes: “The low number of pension funds investing directly in hedge funds should be a concern, as most commentators expected an increase in allocations from pension fund following Regulation 28 changes”. It is possible that many pension funds had invested beyond the current maximum limitation prior to the regulation.
An interesting “mix” of fund performances
Are investors getting “bang for their buck” in hedge funds? The survey suggests those in the heavyweight funds (with at least R1 billion in assets under management) are doing quite nicely. Average returns across these funds came in at 16.1%... In stark contrast funds with less than R100 million averaged only 7.8%. “The result is counterintuitive relative to the general assumption that small funds should be better placed to exploit market inefficiencies and thus be outperforming their larger peers,” notes the survey. Of course you cannot summarise an entire industry with one number…
Upon closer inspection the returns vary vastly from one investment mandate to the next, and between funds with similar mandates. The fixed interest hedge funds delivered 18% for the year, but manager returns ranged from 2.2% (worst) to 44.9%. There was a huge spread of results in the equity market neutral funds which delivered between -11.8% (worst) and 24.1% with an average 4.9%. The equity long/short strategy – which remains a popular hedge fund strategy attracting some 44.9% of total industry assets – achieved 16.1%.
Editor’s thoughts: Pension fund managers and independent financial advisers who assist clients with discretionary investments have a minefield to navigate. If the 950-plus unit trust funds on offer in the Collective Investments Schemes space are not enough, you can flick through a catalogue of 100-plus hedge fund opportunities. Do you consider hedge fund investments when planning for your high net worth clients? Please add your comment or send it to [email protected]
