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Are retail investors ready for hedge products?

Insight 21 September 2021

Are retail investors ready for hedge products?

The South African hedge fund industry has seen significant changes over the last six years. This fast-paced industry is experiencing an even faster evolving environment. Those who keep up with the change tend to benefit greatly.

Written by Sanne's Nigel Moyo, Business Development Specialist and Werner Gerber, Associate Director.

Benjamin Franklin said, “...but in this world nothing can be said to be certain, except death and taxes.” Never has this statement been truer than in 2020. COVID-19 has forced us to rethink the way we interact with each other, the way we conduct business, and the way we invest our money.

The South African hedge fund industry has seen significant changes over the last six years. This fast-paced industry is experiencing an even faster evolving environment. Those who keep up with the change tend to benefit greatly. The framework introduced by the National Treasury for regulating hedge funds in South Africa that has been in place since April 2015 changed the nature of the game for South African hedge fund managers. The regulations provide for two categories of hedge funds:

A hedge fund in which only qualified investors may invest. The Board Notice (“BN”) 52 defines a qualified investor as any person who invests a minimum amount of R1 million per hedge fund and who:

  1. has demonstrable knowledge and experience in financial and business matters which would enable the investor to assess the merits and risks of a hedge fund investment;and
  2. has appointed a Financial Service Provider (“FSP”) who has demonstrable knowledge and experience to advise the investor regarding the merits and risks of a hedge fund investment.

A hedge fund in which any investor may invest in.

An exciting change was the introduction of Retail Investor Hedge Funds (“RHFs”). The introduction of RHFs brought new investment opportunities for retail investors to invest in hedge products, which were previously only available to high net-worth individuals.

Hedge fund managers are always seeking ways to optimize strategies and operations in the presence of regulatory restrictions in pursue of alpha. Understanding the dynamics of allocated capital leads to great insights in understanding investor flows. Fund managers can utilize these insights to tailor their investment strategies to capture market flows.

The transition to a regulated environment led to fund managers drastically consolidating their product offering. The consolidation of hedge funds in the industry was driven by the cost and enhanced regulatory requirements, as well as the additional capital requirements that are required to maintain a category IIA hedge fund FSP license.  Most fund managers opted to classify their funds as Qualified Investor Hedge Funds; due to most existing hedge fund products falling into this category at the time. There was also the restriction of the 200% leverage maximum constraining investment strategies for Retail Hedge Funds, given the leverage prior to regulation. By the end of 2020, QIHFs constituted 63% of the total Assets Under Management while RHFs were only 37%.

In 2020 South African hedge funds had R73.27 billion assets under management according to the statistics published by ASISA, an increase of R4.35 billion from R68.92 billion managed at the end of 2019. Furthermore, data indicates that retail investors committed the most net inflows to hedge funds in 2020 as compared to 2019 when QIHFs had greater inflows. A better understanding of Hedge Funds, greater investor protection and tax certainty may have played a significant role in the increased retail net flows. Using a sample of 70 hedge funds administered by Sanne Fund Services, the first quarter of 2021 shows a continued trend in higher flows committed to retail hedge funds which was also observed in 2020. Furthermore, performance data for Q1 2021 published by HedgeNews Africa, shows a positive correlation between RHFs and QIHFs.

A crucial factor affecting flows in the hedge fund industry is the oversight of the Board Notice (BN) 90 which does not permit Collective Investment Schemes (CIS) in Securities to invest into Regulated Hedge Funds. This shuts down the opportunity for new flows in the industry. The ASISA hedge fund committee and the South African hedge fund community have been engaging the regulator regarding the BN 90 oversight. The amendment of the BN 90 to permit CIS in Securities to invest in Regulated Hedge Funds will be a significant driver for future growth in the hedge fund market.

There is a newly sparked interest in the retail space from hedge fund managers and this is likely to increase the number of hedge products available to retail investors. Also, fund managers are placing retail hedge funds onto Linked Investment Service Providers (“LISPs”) to attract a wider base of investors.  LISPs are proving to be a platform for further growth in the hedge fund space. These platforms are utilizing the capabilities of the broader Independent Financial Advisor (“IFA”) network. A LISP provides ease of access to various unit trust and hedge fund portfolios, thus providing the retail investor an ability to diversify their exposures. LISPs currently accepting hedge funds include Absa, Allan Gray, Momentum Wealth, Glacier by Sanlam and Wealthport.

Fund managers seeking to structure a new fund or restructure an existing fund will need to listen to the sounds of the market and understand where the flows are coming from. Coupling the understanding of the capital flows with other market factors while aligning with specific investment objectives will increase the odds of success for fund managers.

How Sanne can help?

We understand that in trying to keep up with the changing industry regulations and shifting priorities; gaps and inefficiencies are created. We partner with fund managers to assist them in focusing on value-added activities to sustain growth.

  • Assist in setting up a fund;
  • Assist in restructuring an existing fund;
  • Assist in compliance and applicable regulations;
  • Assist in formulating appropriate performance fee methodologies.

Reach out to Nigel Moyo or Werner Gerber directly to find out how Sanne can assist you and your business.

Reach out to our team to assist you with your hedge fund requirements.

Let's talk...

South Africa
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Werner Gerber Associate Director - South Africa
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