Hedge Funds: Namibia’s hope to increase market capitalization and liquidity
By Arney Tjaronda
BBA Student: Banking & Finance Major at the University of Namibia
Over the course of years, Hedge funds has been a driving force for the Johannesburg Securities Exchange (JSE) market. They have been nicknamed the miracle boy of the JSE due to its performance, so much so that in 2020 alone- despite the pandemic-the Single Manager Composite Index was +6.19% (HedgeNews Africa, January 18, 2021). How is that so? Before answering that question, I will define what hedge funds are.
Definition of hedge funds
According to Fernando (January 24, 2021), hedge funds are alternative investment funds designed to protect investment portfolio from market uncertainty, while generating positive returns in both the ups and downs of the markets. This goal is achieved through different investment strategies to hedge while maximizing their performance. The first hedge fund was launched by Alfred Winslow in 1949. He was inspired to manage money through investment schemes and further set forth to try to minimize the risk in holding long-term stock positions by short selling other stocks. This investing innovation is now regarded to as the classic long/short equities model. Jones also employed leverage to enhance returns.
Understanding hedge funds
To understand hedge funds better, one has to look at the type of entity, structure and how they make money. They are formed through offshore corporations, limited partnership or limited liability entities with incentive fees as compensation for fund managers for managing investor’s capital. They are not Unit Trust funds. In most cases, hedge funds are limited to certain individual who has minimum or above N$ 1 million dollars. Hence, there are a lot of barriers to entry not only for potential investors, but for hedge funds too. Hedge funds are highly regulated in every country to protect investors and to prevent unethical practices like insider’s trading, stock market manipulation and any other fraudulent activities that may arise from unethical individuals.
Regulation of hedge funds in South Africa
Hedge funds provide lucrative investment opportunities. All they require to be operational is a well- regulated environment. Hedge funds in South Africa were launched in 1995, however the regulations of the first pool of hedge funds only came in 2003. During that period between 1995 to 2003, the industry had grown to R 2.3 billion and that is when the Alternative Investment Management Association (AIMA) SA chapter was formed due to an increase in hedge funds. Over the years hedge funds where not regulated up until in 2015, when they fell under the Collective Investment Control Act 45 of 2002 (“CISCA”).
Additionally, hedge fund managers were regulated under the Financial Advisory and Intermediary Services Act 37 of 2002 (“FAIS”). Stakeholders hoped that regulating hedge funds will introduce a flow of new assets into the industry, but the opposite happened. The regulatory burden was costly for many without the compensation of additional asset flow. The Financial Service Board (“FSB”) stepped to relax certain provisions that were in place. (Kopke, January 5, 2018)
Under CISSCA, hedge funds needed to be approved and registered in two categories:
Retail hedge funds- these were marketed by any person
Qualifying investor hedge funds (QUIFs)- these could only be marketed to a person who:
i) invest a minimum investment amount of ZAR 1 million per hedge fund as stated earlier.
ii) 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, or has appointed a financial services provider who has demonstrable and experience to advise the investor regarding the merits and risks of a hedge fund investment.
Hedge funds typically have a manager who is responsible for all aspects of the management and administration of the scheme. Those that does not permit members of the public to invest are usually not regulated, however their investment managers and fund administrators of hedge funds still require authorization under the FAIS Act.
Nonetheless, for further understanding of how hedge funds are regulated. It is best to consult CISCA and the Government Notice 141 of 2015 and Board Notice 52 of March 2015 (both published in accordance with the CISCA).
Performance of hedge funds on the Johannesburg Securities Exchange (JSE)
The main goal of hedge fund is to outperform the stock market while maximizing profits for their investors. Assuming that there is a positive relationship between hedge funds and the JSE.
Before my free trail expired, I was fortunate enough to gather information on their performance from HedgeNews Africa over the years (2015-2020)
The South African Funds of Funds Composite ended the year at 9.78%. The South African Single-Manager Composite was 11.8%, while the South African All Bond Index was down 3.93% for that same year.
The South African Funds of Funds ended the year at 1.28%. The South African Single-Manager Composite was 5.27% while the South African All Bond Index returned 15.4% for that year.
The South African Funds of Funds ended the year at 4.53%. The South African Single-Manager Composite added the 5.89% for the year, while the South African All Bond Index returned 10.22% for that year.
The South African Funds of Funds ended the year at 2.47%. The South African Single-Manager Composite added the 5.18% for the year, while the South African All Bond Index returned 7.69% for that year.
The South African Funds of Funds ended the year at 9.21%. The South African Single-Manager Composite added the 7.89% for the year, while the South African All Bond Index returned 10.17% for that year.
The South African Funds of Funds ended the year at 5.95%. The South African Single-Manager Composite added the 6.19% for the year, while the South African All Bond Index returned 8.63% for that year.
We used the South African Bond Index because we assume that the economy is declining slowly and because they have potential for profit. Hedge funds usually purchase distressed debt (in form of bonds) at a very low percentage of par value. For example, if a company is distressed due to bankruptcy, a hedge fund can sell the company’s bonds for a considerably higher price. This is how they get higher returns. Such strategies are often very attractive to hedge funds.
Where hedge funds can help Namibia’s situation
The Namibian Stock Exchange (“NSX”) is the only stock exchange in Namibia, with a total market capitalization of US$ 145 billion as at end 2014, making it the second biggest exchange in Africa in those terms (Source: NSX).
Being the second biggest exchange is an achievement but it is just sad that Namibia does not have hedge funds. Sure, one would argue that we have Asset Management firms, but the question is, are they enough and do they provide a solution to the NSX has? For those who don’t know the Namibian Stock Exchange is very illiquid. Illiquid in a sense that even the smallest trade can have a huge effect on the stock market.
Traditional form of asset management is a long-only strategy designed to offer various levels of equity exposure in certain industries, this leads to an overshooting of prices on the NSX. Additionally, the problem with asset management is that they do not have various strategies to combat risk.
Unlike traditional asset management, hedge funds are much more flexible, have more aggressive investment strategies, they can long or short sell. With strategies like that, hedge funds can help bring prices back into equilibrium. Hedge funds have the ability to add diversification and also reduce risks.
While traditional asset management might turn over their portfolio by 50% in a year, a hedge fund can turn over theirs countless of times. Hedge funds focus on small caps, distressed securities and help emerging markets like the Namibian Stock Exchange.
In conclusion, I strongly believe that with proper regulation by NAMFISA and implementation of hedge funds the Namibian Stock Exchange will be a whole lot better. But again, Its only one man’s opinion.