Hedge funds get over 'cowboy' image

New regulations require that funds be overseen by a management company. (Flickr)

New regulations require that funds be overseen by a management company. (Flickr)

The rules enhance oversight of hedge funds by requiring a separate management company, administrator and trustees to check and balance each other. Managers must report holdings each quarter to investors and the Financial Services Board, the country’s regulator.

It’s a move that may shoot down the industry’s “cowboy image” and unlock more of the 10% of pension fund investments that can be allocated to hedge funds, industry insiders said.

“That 10% can be a substantial amount of money, given the assets under management in the pensions industry,” Udesh Naicker, the head of hedge fund regulation at the FSB, said in an interview last month.

Hedge funds sometimes use short-selling, borrowing and derivatives in addition to traditional stock picking. Philippa Owen, the chief operating officer of Tower Capital Management, said some hedge fund investing strategies that take on risk by borrowing to fund bets on market directions had hurt the industry’s reputation.

“These are generally the types of strategies that have been linked to a cowboy image globally and are unfortunately the ones that make the headlines when the bets go wrong,” she said.

Sharing the same rules as traditional funds on how they report activity and sell themselves would “certainly help pension funds and other investors gain more confidence in hedge funds”, she said.

In South Africa, despite robust investment processes, asset segregation and infrastructure, “the industry has been tainted by perceptions of rogue traders, substandard infrastructure and the gun-slinging cowboy caricature,” Bradley Anthony, the chief investment officer of Fairtree Capital said.
“For this reason, the vast majority of South African hedge fund managers not only welcome the regulation but have actively participated in the processes which contributed to its introduction.”

The new rules, which change hedge funds’ classification to what South Africa terms “collective investment schemes”, are already winning over some investors. Liberty Life Insurance, which administers R220-billion in corporate and individual retirement funds, will be using hedge funds because the clarity and certainty of the new regulations made investors comfortable, Justin Roffey, the company’s head of portfolio construction, said.

“It’s a ‘what I see on the can is what I get’ kind of approach,” Roffey said. “Hedge funds have a great place because of their natural tendency towards low volatility and they produce bond-like returns, so it means we have another way of creating a benefit.”

The new regulations require that funds be overseen by a management company. Funds must be classified either in a new category of retail, known as RIHFs, for ordinary depositors, or as QIHFs for qualified investors required to invest at least R1-million. Retail managers can set their own initial amounts.

Owen said educating investors was important so that they didn’t paint all hedge fund strategies with the same brush.

Investors should also become aware that top South African hedge fund managers were generating better returns than most traditional long-only mandates, while their short positions, or bets on declines in stock prices, provided insurance on the downside, she said.

Owen cited the Tower Fund, soon to be classified as retail, which has a five-year annualised return of 21.9%, and the top-performing general equity fund, Foord Asset Management’s Equity Fund, had gained 20.4% as of July.

Fund management companies will have 12 months after their structure is approved by the regulator to implement the changes from the old regulation. – © Bloomberg

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