Hedge fund regulation - a step in the right direction

Anthony Moore

The number of South African-based hedge funds has increased from 104 in June 2014 to 124 in June 2015, while the total amount managed by South African-based hedge fund managers has risen from R41 billion, to R66 billion for the same period (Preqin's Hedge Fund Analyst Online Service). However, this is still 'small fry' when compared to the estimated US$2 trillion attributed to the global hedge fund industry.

The reason for the limited growth of the local hedge fund market is because, up until very recently, its has not been directly regulated under South African law, and indirect regulation resulted in hedge funds only being available to a select group of experienced investors. Over and above this, a number of high profile scandals have not helped the largely misunderstood world of hedge funds.

However, the introduction of the new regulations to the hedge fund industry will hopefully serve to improve their reputation by demystifying it, and act as a catalyst in aiding it on its journey to maturity and growth. Set to be implemented from 1 April 2016, the new regulations will require all hedge funds to be registered in terms of the Collective Investment Schemes Control Act (CISCA). They have divided hedge funds into two categories - Qualified Hedge Funds, which are limited to institutions, and Retail Hedge Funds, which are open to ordinary investors.

The aim of the regulations is to provide better protection to investors, assist in monitoring and managing systematic risk to the financial services industry, enhance transparency within the industry, and promote the development of the financial markets. Although the regulations have been met by some with criticism and reproach, these new regulations should go a long way in promoting the long-term integrity of the hedge fund industry, and they should hold the industry in good stead by opening up future growth potential. Furthermore, enhanced regulatory certainty may also lead to reduced set-up costs, as even though hedge funds tend to be bespoke arrangements, regulated structures will inevitably become more standardised.

Having said that, care must be taken to ensure that hedge funds do not become over-regulated. The key driver of hedge funds remains their ability to invest in practically any investment, and any restrictions implied by regulatory overlay will inevitably affect their returns. In fact, experience in Europe has demonstrated that there is a considerable returns gap when comparing regulated hedge funds against non-regulated ones.

What is certain, however, is that up to now, South African hedge funds outperformed in 2014 - returning 10,10%, compared to the 4,51% achieved by the Preqin All-Strategies Hedge Fund benchmark. This strong return has grabbed the attention of investors, locally and abroad, and with the new regulations, this is an industry that is clearly headed in the right direction. Not only has the number of hedge funds seen a dramatic increase, but there has also been an increase in the amount of foreign investors who are seeking to invest in South Africa and the African continent at large, as well as the aggregate assets under management.

As investor appetite remains robust and returns continue to show impressive results - hedge funds are certainly an area that any astute investor should keep their eye on. Due to the foundations put into place by these new regulations, MET Collective Investments is confident that in the next five to 10 years, hedge funds will form part of all investment portfolios.