From just a handful of funds with some ZAR1.4bn in as recently as mid-2002, the South African hedge fund industry had grown five years later to more than 130 funds with at least ZAR26bn in assets u
From just a handful of funds with some ZAR1.4bn in as recently as mid-2002, the South African hedge fund industry had grown five years later to more than 130 funds with at least ZAR26bn in assets under management. Industry members predict that the current soaring growth rate will be maintained for some time, pointing to plentiful capacity available in existing funds and a level of allocation to alternative assets which remains well below those in other markets.
Up to now the South African industry has been constrained to some degree by restrictive rules governing investment in alternatives by pension funds, a widespread lack of understanding about the asset class among both institutions and private investors, and uncertainty created by a lack of regulatory oversight. Abroad, investors turning from developed to emerging markets have focused more on Asia and Latin America than Africa and its largest economy.
But those factors are set to change to a lesser or greater degree, to the benefit of South African managers, many of which are now developing the extended track records of success that conservative institutions are looking for. At the same time the industry is becoming broader and more sophisticated as established asset managers launch alternative products, and the dominance of equity long/short and market neutral strategies gradually diminishes while the asset share of multistrategy funds soars.
The most authoritative source of facts and figures on South Africa’s hedge fund industry is the annual survey conducted by Novare Investments, a manager of funds of hedge funds. In its latest report published last October, Novare says industry assets grew by some almost 70 percent in the 12 months to the end of June 2007, from ZAR15.4bn to ZAR25.9bn, while the number of single-strategy funds it identified grew from 90 in June 2006 to 131 from 78 managers a year later.
‘We’ve seen exponential growth in the South African hedge fund industry over the past five years,’ says Carl Liebenberg, until recently the chief executive of fund of funds manager Clade Investment Management. ‘This is largely as a result of the take-up of hedge funds by institutional investors over the past two or three years, although initially the industry developed thanks to private individual wealth.’
Novare’s figures cover rand-denominated onshore funds and portfolios that use some kind of short asset exposure or short selling and that employ some degree of leverage, and group together managed accounts and pooled funds that share the same strategy as a single entity. It no longer includes in its survey absolute return funds, unit trusts that obtain short exposure through derivative positions and which accounted for a further ZAR3.7bn in assets at the end of June.
At least 33 new funds were established over the year to the end of June. Novare says that whereas in the past most new hedge funds were set up by managers starting their own business after leaving large asset management firms, the majority of start-up funds are now launched by large asset managers, boutique hedge fund houses and niche asset management companies as an expansion of their product offering.
These funds attracted 12 per cent of all new inflows into the industry and 40 per cent of the ZAR2.2bn total for new funds, while hedge funds launched by brokerage houses took 9 per cent of total new inflows and 28 per cent of inflows into new funds. However, Lee Dalley, a portfolio manager with fund of hedge funds provider Blue Ink Investments, cautions that a lustrous reputation in long-only investment is no guarantee that managers will be able to replicate their success in the hedge fund arena.
‘We are seeing more big names from the traditional long-only space setting up as hedge fund managers, but just because you’re a good traditional manager, that doesn’t necessarily mean you will be a good hedge fund manager,’ he says. ‘When we choose managers, even for big names from traditional fund management we need to see some sort of track record before we get too carried away about their hedge fund.’
Blue Ink has established a business called Blue Incubator to provide a structure to assist the development of new managers with promise. ‘We started off looking at very different strategies to try to differentiate ourselves from our competitors,’ Dalley says. ‘To begin with we are putting up in-house risk capital, but in the future we may create an entry point for investors who want to spice up their allocation even more by going into start-up managers.
‘There is also empirical evidence that start-up managers deliver the biggest investment returns in the first couple of years of their life. But that’s not the main reason for setting this up, which is to find potentially good new managers and ideally keep them for ourselves to provide additional capacity that we can allocate to.’
Legae Capital, a joint venture between Blue Ink and Legae Securities that specialises in institutional investment, falls under a South African government programme to encourage black empowerment in business, and Dalley says: ‘We have an objective to help transformation in the industry and are very supportive of black hedge fund managers. Two of the black managers we have seeded have been very successful over the past couple of years.’
Inevitably some start-ups fall by the wayside. Nine funds tracked by Novare closed in the 12 months to the end of June, mostly due to the loss of seed capital or the departure of the fund’s manager. However, South Africa also saw its first hedge fund blow-up when the ZAR200m Evercrest Aggressive Fund lost 66 per cent of its assets in April 2007 through a leveraged bet on a fall in the share price of financial service group Sanlam; in the event it rose by more than 17 per cent.
As elsewhere in the world, growth in the hedge fund industry is being accompanied by concentration. The 10 largest hedge funds together managed 40 per cent of total hedge fund assets, with a quarter of the total represented by the seven hedge fund managers with a total of more than ZAR1bn across all their single strategy hedge fund products. Novare says a further 30 per cent of total industry assets were in hedge funds ranging between ZAR200m and ZAR500m in size; funds smaller that ZAR100m accounted for less than 7.5 per cent of all industry assets.
According to the survey, funds of hedge funds continue account for the lion’s share of South African single strategy hedge funds, with 59 per cent of all investments, but their share of total new investment fell back to 42 per cent in the 12 months to the end of June from 79 per cent a year earlier. Novare says this could be down to funds of funds demanding a longer track record from new funds before investing.
High net worth individuals accounted for 18 per cent of total hedge fund assets, pension funds for 7 per cent and life funds – which held 20 per cent of admittedly a much smaller total in 2004 – 4 per cent. Offshore investors accounted for just 1.2 per cent of domestic South African hedge fund assets, but tend to invest in South Africa through offshore entities that often mirror domestic vehicles.
The current restriction on pension funds investing more than 2.5 per cent of their assets in an ‘other investments’ category that includes private equity as well as pension funds has influenced the kind of structures employed by hedge fund managers. While more than half of industry assets are held in limited partnerships, the next largest share – 21 per cent – is in debenture structures, because this offers institutions greater investment flexibility.
‘If you use a particular type of structure such as a debenture, it can be classified under the listed debenture category,’ Dalley says. ‘This enables pension funds to allocate a greater share of their assets to hedge funds because their allowance for investment in listed debentures is much higher, although it depends on what other assets they are holding within that allocation.’
According to Novare, almost 40 per cent of the new funds launched over the year to June 2007 employed a debenture structure, a larger share than limited partnerships. ‘Hedge fund managers are creating a note that invests through a structure into the underlying funds,’ says Liebenberg, who with Clade was instrumental in launching the South African Hedge Fund Index in August 2006 in collaboration with the Bond Exchange of South Africa.
Novare’s survey figures make clear that equity long/short remains the dominant strategy for South African managers with 53 per cent of total assets, followed by equity market neutral with 19 per cent and fixed-income arbitrage with 4 per cent, while no other distinct strategy accounted for more than 2 per cent of total industry assets.
While long/short and market neutral still accounted between them for 72 per cent of total assets last June, compared with 74 per cent a year earlier, their combined share has dropped from 91 per cent in 2005. However, the most striking year-on-year change was the increase in the number of multistrategy funds from four to 11 and the doubling of their share of total assets to 14 per cent (and 18 per cent of the assets of funds launched over the previous 12 months).
The growth of the industry and the redoubling of managers’ efforts to win institutional assets are reflected in the growing level of transparency offered to investors. According to Novare, by June funds accounting for 38 per cent of industry assets provided daily portfolio holdings, while funds accounting for 75 per cent offered at least monthly transparency; the proportion offering portfolio transparency only quarterly fell from 6 to 2 per cent. Funds accounting for 24 per cent of total assets provide daily net asset values, and funds with 62 per cent of asserts provide NAVs at least monthly.
The proportion of funds using outsourced third-party administration is also rising, accounting for 79 per cent of industry assets at the end of June. Novare identifies five South Africa-based administrators servicing at least 119 local funds with assets exceeding ZAR20.5bn. Almost all of the country’s funds have an independent auditor, and funds managing 75 per cent of assets use one of the six prime brokers serving the South African market; a handful use more than one prime broker, while the remainder are funds managed by larger asset managers with internal trading desks.
The growing use of outsourced administration not only reflects global best practice (outside the US, at least) but reflects funds’ growing sophistication, according to Veit Schuhen, chief operating officer of Maitland Fund Services. ‘Hedge funds are becoming more complex than they were a couple of years ago, so the administration becomes more complex,’ he says. ‘It’s no longer just a question of NAV calculation. For due diligence and risk reasons, investors increasingly expect a third-party administrator – and regulators prefer them too.’
According to Novare, the potential for growth of the South African hedge fund industry is illustrated by the fact that its aggregate assets last June accounted for just 0.6 per cent of the total market capitalisation of the Johannesburg Stock Exchange, even after growing by more than two thirds over the previous 12 months. In addition, survey respondents said they had more than ZAR30.5bn in available capacity, giving the industry room to more than double even before any expansion of the financial markets in which funds trade.
