30 September 2021
INVESTING
The most exclusive club is open, but where is the door? BY MICHAEL TITLEY Business Development, Laurium Capital
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or many years, hedge funds in South Africa were unregulated and available to only the wealthiest via complicated structures. This changed with the introduction of the Hedge Fund regulation under CISCA in 2015, essentially opening the door to retail investors. With South African hedge funds being some of the most regulated and transparent in the world, the black box risky label that has been internationally attached to the asset class is unwarranted. Fortunately, hedge fund managers in South Africa have proven themselves to be more conservative than their international counterparts – there are several experienced SA hedge managers in the country, including Laurium Capital, that have 10- to 20-year consistent track records to prove it. Hedge funds are obviously not without risk and it is very important how this risk is managed. Risks like liquidity, leverage limitations and net positioning, are all regulated
and integrated into the portfolio risk management on a daily basis. The relatively small size of the hedge fund industry (R73bn according to the 2020 HedgeNewsAfrica report) versus the long-only R3tn, makes it highly flexible when taking positions. As hedge funds carry a sizeable cash position at all times, the fund does not need to sell a position in order to take advantage of a new opportunity. This magnifies the nimbleness to exploit the full breadth of the liquid market and its broad investable mandate. Reporting has significantly improved with the regulation of hedge funds. Governed by CISCA, hedge funds are required to report fact sheets, total expense ratios and positioning. A concerted shift has been made by the SA hedge fund industry to meet investors’ requests for more information. The combination of the improved regulation, successful performance and improved understanding of hedge funds is driving increased demand in South Africa currently. In our recent webinar poll on hedge funds, 78% of the audience voted that hedge funds should receive a weighting of between 5% and 20%. The question asked by these interested parties now is: how does one access hedge funds; where is the door? Given the current wording of Board Notice 90, unit trusts cannot make an investment into a hedge fund. The industry remains hopeful that this will be amended in the much-
anticipated revamp of Board Notice 90. In the interim, the inclusion of hedge funds for financial advisers can either be done directly into the fund or via a model or wrap fund. Going direct can be quite onerous for retail investors, given the minimum investment requirements and the choice of funds. A better solution would be gaining access to a pre-approved select list of funds via the LISP platforms. This would provide comfort to allocators that the hedge funds have passed due diligence processes and carry the LISPs’ approval. They can then make a choice of the hedge fund strategy they require, and split their allocation across a few funds. Although unlimited for discretionary investors, Regulation 28 limits single manager hedge funds allocations to 2.5% and fund of funds to 5%. With the overall hedge limit being capped at 10%, an allocator could split fund their allocation to hedge across four different funds equally. This has not been possible up until now as no one could find the door to a LISP with a selection of approved hedge funds available. This is changing as several LISPs are seeing the demand for hedge funds, allocating the research time, and adding their preferred funds to their platforms. If you are interested in adding a great diversifier to your portfolios, offering equity-like net returns at lower volatility or elevated returns at market-like volatility, please contact your preferred LISP consultants to motivate for hedge funds to be added to their platforms.
“Unit trusts cannot make an investment into a hedge fund”
Where next for credit markets? BY MATTHEW DUGGAN Head: Syndicate, Absa Corporate and Investment Banking
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he year 2020 was a historically challenging one for all market participants. Investors and bond issuers alike watched as charts spiked, graphs dipped, and markets reacted to the unfolding economic crisis. “In the markets, we saw unprecedented volatility across every asset class,” says Matthew Duggan, Head of Syndicate at Absa CIB. “This was greatly exacerbated by challenging liquidity, which ultimately resulted in the central bank taking action in the government bond market.” That illiquidity was most apparent in the corporate credit market. “Now, six to twelve months later, there are still elements of that ‘muscle memory’ from an investor perspective,” Duggan says,
JONATHAN BURNETT Head: Structured Trading, Absa Corporate and Investment Banking
adding that investors have responded to the crisis environment by requesting longer lead times into primary issuance. “They are no longer willing to participate in what could be deemed to be ‘stale’ financials. Understandably, enhanced credit work is required to participate in this market environment.” Primary market recovery Primary markets, which enable issuers to raise new debt, have started to recover in 2021 after a significant drop-off in activity during the height of 2020’s crisis period. But in the face of a wider issuance spread environment, many corporate issuers were initially reluctant to come to public markets for fear of resetting their credit
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curves. “In the current uncertain economic environment, we are also seeing much greater differentiation from a credit pricing perspective,” Duggan adds. “We expect this trend to continue in the near term.” One bright spot in all of this is that issuance by banks has been particularly strong and well supported. “As concerns around bank credit quality have alleviated, there has been strong demand and spread tightening for the instruments that reference a lower part of the capital structure,” Duggan says, pointing to the Additional Tier 1 and Tier 2 instruments that ensure a bank’s capital adequacy. Secondary market snapshot Meanwhile, Jonathan Burnett, Head of Structured Trading at Absa CIB, says that while secondary market volumes on the JSE were “decent” in 2020, 2021 has seen a slight drop-off. He believes that volatility in the yield curve and a “wait-and-see” approach from investors are contributing factors. “Bank and high-quality corporate spreads have somewhat retraced the drastic flight to quality tightening that we saw post-COVID,” he says. “Corporate spreads for good names have been tightening, but – speaking in mid2021 – the jury is still out as to whether this is a sustainable trend for the rest of the year.” Creating a virtuous circle Absa sees an opportunity to provide increased secondary liquidity in this space, which would help both issuers and
investors. “As a bank, we have dedicated more resourcing and balance sheet to the activity of market-making South African corporate credit,” says Burnett. “We hope this will better price discovery, liquidity and confidence in what we know is a key part of our economy’s capital market.” Burnett says that a more liquid and efficient secondary market will help arrangers to demonstrate best execution for primary issuance, and provide a compelling alternative to the loan market. “Historically, primary auctions and private placements have provided price leadership compensating for stale mark-to-market levels,” he says. “But we are starting to see a more balanced market emerge as banks and brokers look to generate more trading activity. For example, the recent spread compression for bank capital instruments has largely been a function of exceptionally strong secondary market appetite.” “Ordinarily, one would naturally use the secondary market as the pricing reference point for any primary activity, but this is impeded by stale pricing and a buy-to-hold mentality on the investor side,” adds Duggan. “We have spent a lot of time improving liquidity from a secondary market perspective, which will help in terms of price discovery. It then becomes a virtuous circle, where investors feel confident around the functioning secondary market, which is a massive benefit in terms of our ability to encourage issuers to come to the primary market.”
