A regulation 28-compliant collective investment scheme (CIS) will be able to invest in retail hedge funds if draft amendments to the CIS regulations are adopted. This is one of three changes the FSCA is proposing to make to Board Notice 90 of 2014.
The two other proposed changes are:
- Allowing CIS managers to include actively managed exchange traded funds (ETFs) in their portfolios; and
- Increasing the cap on an underlying portfolio’s offshore exposure from 20% to 45%.
Board Notice 90 of 2014 (BN 90) determines the securities and assets in which a CIS can invest, and the limits and conditions under which securities may be included in a CIS portfolio.
The FSCA said it and the Prudential Authority are reviewing BN 90, but this will take considerable time to complete and will require extensive consultation. Therefore, the FSCA has identified the abovementioned aspects of the board notice as those that it wants to address in the interim.
Earl van Zyl, the head of product development at Allan Gray, said the proposed amendments are in line with discussions the industry has had with the FSCA in recent years.
“We welcome the FSCA’s efforts to provide certainty on these three aspects while it and National Treasury continue the comprehensive review of BN90. Investors should be aware that since these are still proposals, final amendments may differ.”
Levelling the playing field with retirement funds
Regulation 28 of the Pension Funds Act sets out the investment limits and requirements that apply to retirement funds in South Africa. The regulation aims to ensure that retirement funds invest in a diversified and appropriate mix of assets to minimise risk and maximise returns. This mix typically includes equities, bonds, property, and cash, with limits set on the percentage of assets that can be invested in each category.
The FSCA said unit trust funds that comply with regulation 28 should be allowed to invest in retail hedge funds (RHFs), subject to the same limits that apply to retirement funds in terms of regulation 28.
A further requirement will be that the hedge funds into which a unit trust invests must have daily pricing and repurchases, to ensure that the liquidity profiles of the CIS portfolio and the underlying hedge fund are matched.
The FSCA noted that retirement funds can invest in hedge funds, but unit trust funds that comply with regulation 28 cannot. This, the Authority said, has resulted in an uneven playing field between the asset management industry serving retirement funds and CIS portfolios that aim to fulfil the same role.
The FSCA said there were “clear benefits” for including hedge funds in a CIS portfolio. Hedge funds can reduce the overall risk of the portfolio, minimise drawdowns, and generate a smoother return profile for investors.
Allowing unit trust funds to access hedge funds will support the growth of the hedge fund industry, which will help to reduce the costs associated with regulation, the Authority said.
Van Zyl said although the proposal makes it possible for managers of regulation 28-compliant funds to allocate to RHFs, and therefore expands the universe of potential investors for RHF managers, it is not clear that this flexibility will necessarily increase the total retail assets invested in RHFs significantly, at least over the short to medium term.
“Importantly, regulation 28-compliant funds will still need to ensure that their RHF exposure complies with the RHF exposure limits of regulation 28, and retail retirement fund investors themselves will need to continue to comply with the same regulation 28 exposure limits.”
Expanding the investment universe
The FSCA said the introduction of actively managed ETFs will help to expand the investment universe for investors, and thus other CIS portfolios.
Actively managed ETFs will be operated and managed in the same way as index-tracking ETFs; only the investment mandate will differ.
The benefit of an actively managed ETF is that it is not forced to be fully invested or buy derivatives to ensure investment equal to the index it tracks. Therefore, an actively managed ETF can hold more assets in liquid form, providing for more redemption liquidity in the portfolio, the FSCA said.
The FSCA supports creating an enabling environment for the establishment of, and investment into, actively managed ETFs. As such, it approved amendments to the JSE Listings Requirements that allow issuers to list and trade actively managed ETFs, subject to certain requirements. These amendments came into effect in October 2022.
Increasing the single portfolio limit
Last year, the prudential limits for offshore exposure and for Africa excluding South Africa were combined into a single offshore limit of 45%.
The FSCA said it has received requests from the industry to increase the 20% limit per underlying portfolio to allow a standard or hybrid portfolio to have an offshore exposure of 45% by investing in one underlying foreign portfolio or one underlying domestic portfolio, such as a feeder fund, that consists only of foreign exposure.
To achieve the most efficient and cost-effective exposure to foreign assets, it is industry practice to invest in foreign portfolios as opposed to investing directly in foreign securities. These foreign portfolios are often part of a foreign scheme managed and operated by a company within the same group as the management company or the investment manager managing the assets of the portfolio.
If a manager wants to achieve the maximum foreign exposure of 45% by investing in underlying foreign portfolios or a domestic portfolio consisting only of foreign exposure, the manager must invest in at least three foreign-exposure portfolios, as the current limit per portfolio is 20%. This impedes the efficient implementation of an investment to gain foreign exposure, the FSCA said.
In terms of paragraph 10(a) of BN 90, a fund of funds must invest in at least two underlying portfolios, and the investment in any one portfolio may not exceed 75% of the market value of the fund of funds. Although a standard or hybrid portfolio cannot be compared to a fund of funds, the requirements to invest in an underlying foreign portfolio are similar. Put differently, in terms of sub-paragraphs 3(3)(a)(ii) and (iii), a standard or hybrid portfolio may only invest in foreign portfolios subject to due diligence and an annual review for compliance with section 65 of the Collective Investment Schemes Control Act.
There is no clear additional risk in standard or hybrid portfolios to justify imposing a far lesser limit (20%) when investing in an underlying foreign portfolio, the FSCA said.
Van Zyl said Allan Gray supports the FSCA’s proposal, because it aligns with the maximum foreign limit of institutional investors and local unit trust funds managed to comply with regulation 28.
“This will make it more efficient for managers of regulation 28-compliant funds to invest in foreign assets where they choose to invest in a foreign portfolio rather than in underlying foreign securities, and it removes the need for the manager to create multiple portfolios to take advantage of the foreign limit.”
Deadline to comment
Click here to download the draft amendment notice.
Click here to download the FSCA’s full statement supporting the proposed changes.
Comments must be submitted on the comments template by 21 April to FSCA.RFDstandards@fsca.co.za.
For further information, contact the FSCA’s Regulatory Framework Department by emailing Marianne van Rooyen at marianne.vanrooyen@fsca.co.za.
