Can hedge funds and asset managers combine effectively?

Gareth Stokes, FAnews Online Editor

Hedge funds are back under the spotlight after changes to Regulation 28 which allow institutional investors to increase their exposure to the asset class to 10%. The decision should open a huge market for hedge fund managers because, in the past, an insti

Hedge funds are back under the spotlight after changes to Regulation 28 which allow institutional investors to increase their exposure to the asset class to 10%. The decision should open a huge market for hedge fund managers because, in the past, an institutional investor could allocate a maximum of 2.5% to hedge funds. Under the previous regulation this 2.5% was labelled “other investments” to include investments in private equity and hedge funds, among others.

In real terms this means a pension fund with R1 billion assets under management can now invest up to R100 million (10% of R1 billion) in hedge funds. Prior to the change a pension fund of this size would have bypassed the hedge fund industry because the maximum investment it could make (R25 million, or 2.5% of its total assets) would have been too small.

Regulation 28 lights a spark among South African asset managers

Speaking at the Association of Savings and Investments South Africa (Asisa) 2011 Conference held recently at Sun City, Marilyn Ramplin observed that “everyone in South Africa seemed excited about Regulation 28, the opportunities it created, and the impact it would have on the industry as a whole”. Ramplin, the chief executive officer of Ramplin Capital, delivered a presentation titled Global Asset Management Trends, Challenges and Opportunities.

She said that the changes to South Africa’s regulatory environment would create opportunities for stakeholders across the financial services industry – but she quickly dispelled the myth that the move from 2.5% (admittedly hedge fund investments prior to the change were slightly lower) to 10% would result in a stream of capital moving towards hedge funds. “My experience with international hedge funds and investors is that there won’t be a sudden flood of funds to the hedge fund industry,” she says. “Just because there is a change in regulation doesn’t mean there will be a change in behaviour among those making capital allocations.”

To attract institutional capital hedge fund managers will have to institutionalise their businesses, build robust governance models, maintain independence, offer dynamic risk management processes and risk reporting and get their product mix right. “It is critical for hedge funds to know their customers and set up the optimal mix of long/short portfolios that traditional fund managers favour,” says Ramplin. One “trick” hedge funds could try is to create 130/30 funds and offer these funds to institutional investors. (These funds go long 130% of a portfolio of assets, and short 30%). Under this scenario the traditional institutional asset manager avoids losing business to hedge fund managers and the hedge fund manager gets to utilise their infrastructure and fund management skills.

Giving the clients what they want!

Hedge fund investments typically run into hundreds of millions of rand. “If the hedge fund industry wants to fully benefit from the Regulation 28 change they must give their potential clients what they want,” says Ramplin. Pension Fund Managers are under particular pressure to invest in products that offer transparency, liquidity, sound risk management, accountability and governance, absolute returns and regulation! Traditional outlets for institutional capital are already meeting the stringent requirements brought about by the tighter regulatory environment, so the hedge fund industry will have to play catch up.

Transparency speaks to the fee structure involved in the financial services product and the hedge fund industry will have to address concerns around excessive and complicated charges. And liquidity is an essential consideration when investing large amounts of funds. Fund managers want to know how quickly they can move funds into an out of a particular product. The issues around regulation of hedge funds will hopefully be finalised over the next year or two. Industry insiders say the change to Regulation 28, specifically the recognition of hedge funds as an asset class, will speed up other aspects of industry regulation.

An innovative solution to industry challenges

While hedge funds are hard at work to attract institutional capital the traditional asset managers are looking at ways to extend their product offering into the hedge fund space. Ramplin says they face many challenges in this regard. Fund managers’ initial forays into this investment class were stalled because their systems couldn’t administer long/short positions and they couldn’t load transaction costs on short positions. They also suffered due to severe shortages of skilled front and back office staff and found that long/short managers demanded remuneration well in excess of their long-only managers.

The logical solution was to combine hedge fund managers with asset managers. One of the successful tie ups in the US came about when JP Morgan and Highbridge Capital joined forces. JP Morgan brought its respected asset management brand and excellent distribution network to the table, while Highbridge Capital (a single hedge fund manager) brought its expertise in this type of investing. The result was a highly successful 130/30 fund which attracted $10 billion in record time.

The long and the short (if you’ll excuse the pun) of successful fund management is to satisfy the client. Ramplin concludes: “Our investors trust us [asset managers] with their money because they believe we are better at identifying, understanding and managing the risk we take with their money!”

Editor’s thoughts: Ramplin made a number of interesting points about what asset allocation decision makers expect from the fund they invest in. Ironically, the clients are demanding the same set of protections the regulator is fighting so hard to instil across the industry. They want transparency, liquidity and tight risk controls! If you were in charge of a pension fund would you be prepared to move 10% of your assets into a hedge fund? Please add your comment below, or send it to gareth@fanews.co.za