Thu, 10/09/2009 - 11:02
South Africa's market architecture has withstood the seismic shocks unleashed by the global financial market collapse. While the rest of the world, including the in-favour quartet of Brazil, Russia, India and China, dusts itself off and revisits the drawing board, South Africa is ready to capitalise on its solid foundation and prudent construction in an environment of fast-paced recovery.
A sophisticated, regulated and transparent environment that offers multiple opportunities for alpha extraction in a maturing market, South Africa is unfortunately still often overlooked when it comes to allocations to emerging market economies.
On a structural level, South Africa's infrastructure has the bells and whistles that one should expect from a 'new world' financial system. Its banks are strong, competitive and well capitalised. Over the past few months there have been no crises or need for government bail-outs. There is open communication and collaboration between regulators and market participants, who are already comfortable with the concept of unrestricted regulatory insight into activities and a conservative approach to consumer credit and financial engineering.
The Johannesburg Stock Exchange, South Africa's only stock market, is technologically one of the most sophisticated anywhere across the globe and highly regulated, boasting the eighth largest equity market in the world as well as world-class markets for traditional and single stock futures. South Africa comprises 7.5 per cent of the MSCI Emerging Markets Index, ranking it sixth just behind India.
The South African economy has a resource bias, but also draws value from the broader African continent and international markets through its many dual listings. All this makes for a dynamic, value-driven trading environment for hedge funds.
The outstanding feature of the local hedge fund sector has been the relatively large amounts of alpha that have generated by managers. Research capabilities can be a differentiating factor when it comes to the mid-cap and small stocks that are often overlooked by the majority of analysts, who focus solely on the top 40 stocks or even just the resource sector within the top 40. This leaves an opportunity to identify below-the-radar companies.
Domestic equity valuations are heavily influenced by currency and commodity prices, but the market's mid-range size on a global scale allows for frequent and tradable valuation gaps. Experienced and skilled hedge managers are able to extract factors while managing risk via the highly-developed derivative and asset-lending market. In summary, alpha opportunities exist, and the developed nature of the underlying capital market allows for its efficient extraction.
Only over the past 18 months or so have foreign investors been able access this source of alpha. South Africa Alpha Capital Management (SAACM) manages one of a limited number of investment vehicles available that allow a US dollar investment hedged against the rand, together with a fast-tracked due diligence process, flexibility, diversity and cost-saving benefits when allocating across multiple funds.
The Cayman-incorporated South Africa Alpha Segregated Portfolio Company offers a single access point to eight different strategies, including long/short equity, market neutral, statistical arbitrage and multistrategy funds.
The industry is well supported by an expanding infrastructure of prime brokers, fund administrators and banks. Peregrine Prime is one of the largest prime brokers, servicing one third of all licensed fund management entities, and is the preferred prime broker to the SAACM funds.
A healthy fund of funds industry has developed, and although institutional investors have taken longer than individuals to allocate assets, investments have been resolutely committed through the downturn in the market, although only Caveo Fund Solutions, positioned third in terms of fund of hedge funds market share, succeeded in increasing its assets under management in 2008 - by 30 per cent.
The South African hedge fund industry has just celebrated its 10th anniversary. While a relative youngster compared with highly-developed markets, it has now weathered the 2002-03 bear market and the turmoil of 2008-09. While not entirely unscathed, returns during these periods were compelling and the wholesale redemptions experienced in international markets were not felt locally.
While until recently many industry members contended that a regulated environment is exactly what the hedge fund industry didn't need, the South African reality is that over the past two years regulation has engendered a noticeable sense of investor comfort, reducing redemption stress and allowing the industry to continue to flourish.
In a spirit of true partnership to improve the investment framework, for the past 18 months the South African regulator, the Financial Services Board, has required the mandatory registration of all asset managers, including hedge fund managers. The latter have been subjected to an in-depth assessment of their business and structural viability, as well as of their specific investment management skills.
However, this is not a highly regulated environment that constrains individual manager styles. Instead active dialogue exists between policymakers, policy implementers and industry participants. No ban on short selling was required last year, and despite some fund losses, there were no blow-ups throughout 2008 or in early 2009. There is no holy regulatory grail for hedge funds, but the industry operates in an environment that provides regulatory comfort for both institutional and individual investors.
The most recent development is the launch of a process that will create regulated product environments for hedge funds. This will in time allow all investors the same opportunity to invest in hedge funds, and at the same time ensure that such products embody appropriate levels of risk management, disclosure and transparency.
The South African hedge fund industry is relatively concentrated in equity-based strategies, along with the recent emergence of fixed interest and macro trading styles. This focus on equities, while not ideal in terms of diversification, does make possible very high levels of portfolio disclosure.
This generally occurs daily, and allows for effective mandate and style drift monitoring by allocators. Together with extensive third-party risk monitoring, the high degree of transparency has been a key factor in the insignificant number of South African fund closures resulting from capital losses.
The South African economy has remained intact and resilient throughout the international financial mayhem, and in time this will allow many companies based in the country to expand and grow into other regions of the continent as well as globally. With the underpinning of a strong financial system and a regulator that is engaged in helping the industry to flourish, hedge fund managers have a bright future in South Africa.
Quite simply, global investors and hedge funds can no longer afford to ignore the potential that South Africa offers. It should be a key part of their global investment strategy and will reward them in terms of alpha and value.
Gavin Glick is managing director of hedge fund management platform PIM, Byron Green is managing director of fund of hedge funds manager Caveo Fund Solutions, and Ruth Forssman manages client relationships and business development for the Peregrine Prime business
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