6. HSBC's Alternative Financial Services Market Review Series: Funds of funds start to emerge in South African market
Ian Hamilton, Managing Director, Global Fund Services (South Africa) (Pty) Ltd, outlines recent trends in South Africa's nascent hedge funds market
HW: What is the background to the setting up of the local office?
IH: HSBC's Alternative Fund Services (AFS), previously Bank of Bermuda's Global Fund Services, became interested in establishing a presence in South Africa largely through its relationship with Investment Data Services - a specialist investment administration company at which I was Managing Director.
We had been observing a potential growth market for hedge funds from high net worth individuals and dependent on appropriate legislation, large institutions such as pension, unit trust and insurance providers.
This growing interest, coupled with the South African Financial Services Board's commitment to introduce hedge fund legislation led to the opening of Global Fund Services (South Africa) (Pty) (Ltd) in Cape Town in 2001.
AFS's operation of a hub and spoke software system - whereby operating offices utilise a central core of software - has made it a seamless set up and our operation in Cape Town accesses the best international practises used by AFS globally.
HW: What is the average size of fund launches in the SA market?
IH: The industry is in its infancy with most funds starting around R12m (USD 2m). However, there are a number of established funds in excess of R200m (USD 32m). The optimal size for single strategy funds in South Africa is between R200m and R300m given that the funds are limited to investing in South Africa because of exchange control.
HW: What are the types of strategies being launched?
IH: The initial growth has been in single strategy funds aimed at high net worth individuals. The lack of approved structures has limited the appeal to a wider audience. Fund of Funds are starting to emerge targeting both individuals and retirement funds.
HW: Who is launching these strategies?
IH: The market is evolving into two distinct groups. Single strategy funds are being launched by fund managers that have moved out of an institutional environment to pursue alternative investments. Fund of funds tend to be launched by institutions with established marketing and distribution infrastructures.
HW: What types of fund structures are being launched?
IH: There are two predominant structures:
Limited Liability Partnerships
Neither of these structures fall within the domain of the current Collective Investment Schemes Control Act and therefore have a number of uncertain aspects, for example, taxation.
HW: What is the investor appetite for different strategies?
IH: Investor appetite is difficult to gauge as strategies are mainly limited to long short equity and fixed interest funds. Arbitrage opportunities are limited and distressed debt is yet to emerge.
HW: What is happening on the regulatory front?
IH: Proposals to create a regulatory environment or provide more formal structures are gathering momentum and the Financial Services Board have indicated that they would like a regulated framework to be in place by mid-2005.
As a member of the Institute of Retirement Funds Investment Committee, I am actively involved in assisting the Financial Services Board on how hedge funds work and the types of regulation to introduce to encourage growth in the market.
HW: What are the institutional investment trends in the region?
IH: Institutional investments are currently restricted in three aspects:
i) An urgently needed overhaul of Reg 28 of the Pension Funds Act is required, which makes no provision for hedge funds thereby forcing hedge fund investment into the category of "other", which has a maximum investment restriction of 2,5%
ii) Caution is also required on the current structures and tax uncertainty of investing in hedge funds - it is unclear at present what the tax implications are likely to be for institutions investing in hedge funds.
iii) There is also a lack of knowledge and education on what hedge funds are and how they can be used to diversify risk on the institutional side.
However, the Financial Services Board is committed to bringing about legislation specific to hedge funds, which we believe will greatly encourage further institutional investment.
HW: What is HSBC's competitive advantage in the market?
IH: We are currently the sole service provider of alternative investment administration in South Africa. The Cape Town office is playing a valuable role in developing and supporting the industry and as a result is deserving of its dominant position.
HW: What is the market outlook for the next six months?
IH: The demand for hedge funds in South Africa is in its infancy. Local investors may soon be crowded out of the market as Emerging Market Fund of Hedge Funds and other international markets perceive the value of the South African market. In addition, we expect an increase in investment from institutions as new legislation is introduced.
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