Hedge funds

Risk levels suitable for proposed regulatory framework

Making money in uncertain times
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Apparent from the Novare Investments South African Hedge Fund Survey for 2012 is that hedge funds, which managed assets as at 30 June 2012 of R33.6 billion, continued to adopt a conservative positioning to the market with regard to their risk exposure levels.

According to Eugene Visagie, Portfolio Manager at Novare Investments, one way of measuring risk exposure in a portfolio is to look at gross and net exposure levels. 

Net exposure is the total value of the long positions of the fund less the total value of its short positions, which represents the portfolio’s directional exposure to the market. Gross exposure is the sum of the absolute exposures (long plus absolute values of the short) obtained across all investments in a fund. In this calculation short selling and the use of derivatives increase the gross exposure of a fund.

Visagie commented that the largest hedge fund strategy in South Africa, equity long/short, can be split between equity long/short with a long bias (with 34.7% of industry assets), and with a variable bias (10.2% of assets). Managers with a long bias reported average net equity exposure of 63.0% with an average gross exposure of 146.3%. 

“These figures are interesting in the context of proposed regulation of hedge funds by the National Treasury and the Financial Services Board (FSB). With the intention of enhancing investor confidence, two distinct classes of hedge funds are proposed – those suitable for retail investors, and a restricted class for which there will be different requirements.

“One of the requirements of the retail class is a limit to gross exposure of 200%. From the survey it becomes apparent that, on average, equity long/short managers with a long bias should be able to fit into this framework. This is also the case for the equity market neutral strategy (14.4% of industry assets) reporting average gross exposure of 159.2%,” said Visagie.

Other equity focused managers such as volatility arbitrage reported average gross exposure of 162.9% while multi-strategy funds reported 131.9%. Even though these are not the only prescribed restrictions, it is positive that at least 63.2% of industry assets should fit within the proposed requirements of the retail framework.

In terms of managing risk, proposed new hedge fund product regulation also goes beyond gross exposure to consider other factors, including an independent valuation of the assets of hedge funds. According to the Novare Investments survey, 99.3% of industry assets are already subject to an independent valuation. 

The proposed regulations also address liquidity requirements for hedge funds, with a proposed maximum period of 14 days for the retail class. 

In the Novare survey, managers holding 41.4% of industry assets indicated that they would be able to liquidate their assets within one day, while 24.6% of industry assets could be liquidated within five days. A further 14.5% of assets could be liquid within 10 days, indicating that 80.4% of industry assets could be liquidated within 10 days.    

“This means that, in terms of the proposed regulations, when considering factors like risk exposure levels, administration and instrument liquidity, the bulk of industry assets should be able to fit comfortably into the regulatory framework for hedge fund products,” said Visagie.

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