A number of stringent conditions have been placed on pension funds that wish to have hedge funds in their portfolios, which must be complied with by November 2012.
In terms of Regulation 28 made under the Pension Funds Act, a recent notice from the Financial Services Board (FSB), stipulates the investment criteria for the structure, ownership and protection of hedge fund assets.
Anthony van Eden, chief operating officer at Strate, says that although the requirements seem onerous, it allows for the use of Segregated Depository Accounts (SDAs) held at a Central Securities Depository (CSD). Although the use of SDAs is not mandatory, these account structures allow pension funds to meet the investment criteria, provide enhanced protection for investors and assist with risk mitigation in the market.
“SDAs segregate clients' assets so that should an intermediary, such as an approved nominee company, prime broker or custodian default, the full-legal ownership of securities would remain undisturbed and the investor can continue trading in that account in a relatively seamless manner,” explains van Eden.
“While the nominee structure in South Africa does provide segregation and protection of clients’ assets at the custodian level, SDAs avoid a situation where investors’ securities may be trapped in the books of the failed entity, while the curator or administrator endeavours to identify ownership and return the securities to their rightful owners. As a result, SDAs are designed to reduce market risk,” he says.
“Opening an SDA at South Africa’s licenced CSD, Strate, gives investors the benefit of having these safe-keeping structures at an independent, neutral third party,” van Eden adds.
During the 2008 financial crisis, some global hedge fund investors had their assets locked up in the aftermath of the Lehman Brothers collapse. It took a lengthy, costly administrative process to unwind the ownership structure with some funds even losing a portion of their assets.
“International intermediary and custodian failures, such as the collapse of Lehman Brothers and MF Global, have made it an imperative for South Africa to have mechanisms in place to manage such a potential risk. SDAs are an innovative solution to facilitate the management of risk and enhance value for all stakeholders,” adds van Eden.
“The SDA structure is extremely attractive since pension funds can now enhance investor protection when they utilise the increased limits of Regulation 28”, says Marilyn Ramplin, CEO of Ramplin Capital and the Hedge Fund Academy.
Regulation 28, which came into effect on 1 July 2011, allows for greater investment in a spread of assets and alternative investments by increasing the ceiling that pension funds were able to invest their portfolios into hedge funds from 2.5% to 10%.
“Hedge funds form a very important part of the asset allocation decision because they are primarily about capital preservation by protecting the portfolio on the downside and delivering better risk adjusted returns. Combining the mandate with an SDA structure creates an environment where investors can receive not just a return on assets through the skill of hedge fund managers, but also a return of assets through the segregated account,” adds Ramplin.
“The SDA account is an additional measure for investors concerned about the safety of their assets, transparency and most importantly control of their assets in the event of a bankruptcy. Assets that are locked up in a default scenario cannot be traded or managed and even segregated accounts in the MF Global default will not be receiving 100% of their assets back,” she adds.
After introducing the concept, Strate has seen growing appetite by investors as they increasingly call for higher levels of transparency, increased regulation and improved asset safety in the event of an intermediary, prime broker or custodian failure.
SDAs have been operational in the local market for over a year and were introduced after the new Companies Act came into play, which called for enhanced legal protection for investors.