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SIMON BROWN: I’m chatting with Luke Richardson. He’s a research analyst at PPS Investments. Luke, I appreciate the time today.
A couple of months ago the FSCA [Financial Sector Conduct Authority] released a draft notice. They are amending Board Notice 90. That’s the technical part, but [in short] it allows collective investment scheme managers to include up to 10% into retail hedge funds. This is quite a big deal. The funds are out there, but they’ve just never been sort of regulated in this way that would make it possible for – and I’m thinking in particular– Regulation 28 and the like.
LUKE RICHARDSON: Yes. I think what’s important to note is that Regulation 28 compliance … could have exposure to hedge funds up to 10%, but not a CIS [collective investment scheme] vehicle. So certain advisors who have model portfolios could run a portfolio … that Regulation … had exposure to hedge funds, but it wasn’t possible within a finance structure.
SIMON BROWN: Ah, okay. I see what you’re saying there. Hedge funds are often considered risky, and certainly I think a sort of private investor out there looks at a hedge fund as something which is high risk, high reward. But that’s usually not the case. You’ve got market-neutral funds, you’ve got long-short funds and that’s not their design at all.
LUKE RICHARDSON: Yes, definitely. I think [by] the term ‘hedge fund’ over time, especially out of the US, you’ve got bad credit, especially with some of these cowboys that take on quite a lot of leverage to generate returns and inevitably down the line there’s a blowup and investors lose a lot of money. But I think that the term ‘hedge fund’ is actually very broad and it really is a very pure investment vehicle in the sense that you can utilise various derivative instruments to generate return.
That allows you to generate very consistent returns, either lower on the risk spectrum or basically as the guys popularise it.
SIMON BROWN: And part of it would also be potential – I’m thinking if they’re using derivative structures and the like – could a hedge fund potentially be less volatile while still offering perhaps a market-related return?
LUKE RICHARDSON: Yes, definitely. I think over the last 10 years we’ve seen that, for example, South African long-short hedge funds are probably about half of the assets in the South African hedge fund industry. And for conservative investors, as we said, [in] something like a market-neutral hedge fund, there really are opportunities to earn cash-beating returns at very low volatility. They are great alternatives in your portfolio, essentially in times when cash doesn’t deliver – as we’ve just come out of one of those periods from the market where cash is offering very low returns. So it does make sense to have some exposure to things that can offer you that consistency that you might not be able to get elsewhere.
SIMON BROWN: I suppose one of the key takeaways really is to know what’s in your hedge fund. Do the research or have a financial professional who can do it for you and really understand the mechanics of a hedge fund that you might be investing into indirectly, because there’s going to be tons of different flavours.
LUKE RICHARDSON: Yes, definitely. One of the complexities that I think the regulator is dealing with at the moment is [whether] the hedge fund is the same as equity in terms of risk, because a Reg 28 portfolio can only have 75% in equity and it could have … in hedge funds. So there are hedge funds out there that are essentially 100% equity with a hedge fund overlay. Are they equity or are they hedge funds? I think that’s one of the things that the FSCA still needs to fully grasp in terms of risk regulation and the way it will be written in equity, because hedge funds could be equity 100% or they could be very conservative funds that are closer to in their low or in their high fund in the long-only space in terms of their allocation.
SIMON BROWN: I take the point on that, and hence the draft notice. Do we have any idea of timelines or are we just waiting on the next announcement from the FSCA?
LUKE RICHARDSON: I don’t have any sense of time, but I do think that that obviously would be very beneficial to the South African hedge fund industry that has really struggled to grow its assets and, because of the lack of investor access, because retirement portfolios can’t access these products.
I think that there are some really skilled people in the hedge-fund industry who can offer South African investors quite a lot and quite a high-quality offering. But they’ve been hamstrung by legislation for quite some time. So I do think that we are definitely making progress and I think with the advent of these retail investor hedge funds, many of which have daily pricing and are available on platforms, you’re starting to see a bit of the hedge fund … and I think that hedge fund managers are also putting more pressure than before on the regulator to try and make this happen in some way.
SIMON BROWN: That’s a great point. We’ve certainly seen growth in hedge funds in South Africa, but they still remain a very small asset class in the bigger picture.
Luke Richardson from PPS Investments, I appreciate the time.
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