South African investors have increased confidence and appetite for alternative investments

South Africans are becoming more comfortable with ‘alternative investments’. This is borne out by an unprecedented 30% growth in the hedge fund industry’s assets for 2022. The industry ended 2022 with R113bn under management, compared with R86.93bn at the end of 2021.

South African investors have increased confidence and appetite for alternative investments

According to the Association for Savings and Investment South Africa (Asisa), the hedge fund industry attracted healthy net inflows of R5.3-billion in 2022, as opposed to net outflows of R2.5-billion in 2020.

Hayden Reinders, convenor of the Asisa hedge funds standing committee, says the industry has had to endure several lean years following the implementation of crucial reform initiatives, which resulted in comprehensive regulation and the consolidation and closure of funds, stabilising at 216 hedge funds.

In 2015, South Africa became the first country in the world to implement comprehensive regulation for two categories of hedge funds. Qualified hedge funds are aimed at investors with a solid understanding of these funds, with a minimum investment of R1-million. Retail hedge funds are open to all investors and the average minimum lump sum investment is R50,000.

“Seeing strong growth numbers for the industry is a welcome development and hopefully indicates that hedge funds in South Africa are increasingly being accepted as an important investment tool in mitigating market volatility,” Reinders says, adding that amendments to Regulation 28 of the Pension Funds Act are expected to lead to more growth in 2023.

The amendments separate hedge funds and private equity investments, allowing local pension funds to invest 10% of assets into hedge funds and 15% into private equity investments.

“The amendments enable hedge funds to operate on a more level playing field, which should result in stronger inflows,” says Reinders. “Most pension funds are nowhere near the 10% maximum, which means there is plenty of room for growth.”

According to Reinders, 37% of assets under management were held by retail hedge funds at the end of December 2022, while qualified investor hedge funds held 63% of assets. The net inflows in 2022 were driven predominantly by retail hedge funds, which attracted net inflows of just over R4-billion, while qualified investor hedge funds recorded net inflows of just over R1-billion.

Private debt one of the top three alternative investments

Meanwhile, private debt is another alternative asset class seeing huge growth in South Africa. These instruments offer lower volatility, lower listed market correlation and better cash returns relative to those provided by traditional asset classes such as equities, fixed income and bonds.

Also known as direct lending, private debt is a fixed-income alternative investment which is basically a loan from a non-bank lender. Non-bank lenders provide private loans for various purposes, such as to bridge property transactions, develop real estate, finance business growth, provide working capital and fund infrastructure. These loans generally have shorter repayment periods.

Dino Zuccollo, head of product development and distribution at Westbrooke Alternative Asset Management, says private debt investors enjoy the following benefits:

  • Higher returns than traditional fixed-income investments, such as bonds.
  • Lower volatility than publicly traded investments, as the private market nature of the assets removes mark-to-market swings inherent in the listed markets.
  • Potentially lower risk as the investments typically benefit from hard asset security and (when managed by an experienced investment manager) are made to companies with stable cash flows and solid fundamentals.
  • Portfolio diversification as the investment risk profiles generally differ from those provided through traditional listed access points.
  • Predictable cash flows as the borrower typically pays set interest amounts and principal on a regular basis.
  • Potential tax efficiency due to the ability for enhanced investment structuring.

The latest Westbrooke Alternative Asset Management Investing in Alternatives Wealth Partner Survey shows that private debt, structured products and hedge funds are the top three alternative investments for sophisticated South African investors.

Zuccollo says 61% of respondents indicated that they planned to increase their allocations to alternatives, allocating up to 20% of their portfolios to these investments, while the majority (55%) focused 60% or more of their alternative investment allocation on offshore markets.

Private debt also allows local investors to access opportunities in markets that are otherwise inaccessible to South African investors, such as the UK.

However, Zuccollo warns that investors should look for an experienced manager with a track record of success, as alternatives are complex, may be opaque and difficult to implement, and may be invested in a foreign geography with vastly different risk profiles.

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