Self-regulation helps funds survive "100-year flood"

Self-regulation helps funds survive "100-year flood"

The impact of the global financial crisis on the South African hedge fund industry has been considerably less than the shockwaves felt across the international industry, and the US in particular. Despite some poor returns and a couple of funds electing to close down, one could also argue that the crisis has had a positive impact on the local industry, specifically in terms of its composition and regulation.

What probably shielded the local industry from the worst of the crisis were the already high level of self-regulation and the limited proliferation of asset-backed securities in our market. Investors did not lose significant amounts of capital resulting from the sudden departure of many international funds or write-downs of more than 50 per cent of fund assets. As a result, the industry escaped relatively unscathed with no incidents of fraud and a reputation still intact.

However, what the global financial instability has done for the local industry is to expose those funds that up to now have been able to dress up their beta from a rising market as alpha. With these marginal funds out of the equation, the industry now comprises many high-quality outfits, run by experienced managers with proven track records through the market cycles and even the '100-year flood' that was 2008.

Globally, regulation of the industry has been brought to the forefront, with a widespread call for significant changes. Currently the industry is divided into two camps - those who hope for a completely unconstrained environment, and those who prefer a regulated environment with impartial oversight. An increase in regulation is not expected to result in a knee-jerk reaction from the local industry.

Local hedge fund managers are currently regulated under a Financial Advisory and Intermediary Services Act license, but a joint initiative between the Alternative Investment Management Association's South African chapter and the Association for Savings and Investment SA now aims to extend the regulatory framework at a product level for hedge funds in South Africa. With a high level of self-regulation at a product level already in place, the transition to a regulated product environment should be very manageable for the industry.

As regulation increases, so will the local industry's ability to attract more assets. According to Aima, only 1.3 per cent of South African pension fund money is currently invested in hedge funds, compared with a global average of 18 per cent. This is a direct result of the archaic Regulation 28 of the Pension Funds Act, which restricts pension funds to investing a maximum of 2.5 per cent of total assets in 'other assets' including hedge funds.

While the downturn has been a true test for all types of investment, the South African hedge fund industry has managed to survive the instability while continuing to offer investors an effective diversification tool within their portfolios. In light of the greater certainty around regulation going forward, it would be remiss of investors to exclude the asset class from their overall portfolio.

Sean Morris is a manager for institutional business with Coronation Fund Managers

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