New Hedge Fund Rules
September 17, 2007, Gerald Saacks
New hedge fund rules may require health warnings
Risk disclosures should be available to prospective clients
GERALD SAACKS
The Financial Services Board (FSB) has just published the long-awaited hedge fund regulations, but what exactly do they mean?
Firstly, it is important to note that the regulations regulate only the hedge fund management firm and the qualifying individuals on its staff, rather than the products for their unit trust or pension market.
Secondly, rather than define a hedge fund by its chacteristics – difficult due to the multitude of strategies followed – the FSB has focused on the unique risks of these alternative investments on the advice of the Investment Management Association of SA (Imasa).
Unlike Investors in traditional, long-only investments, investors in hedge funds can lose more money than their initial capital investment.
Consequently, the FSB has used this as a basis for defining hedge funds, in effect including any strategy that could result in losses grater than a fund’s market value.
Two strategies that could result in these types of losses are cited: leverage (gearing) and net short positions, which can be illustrated in the following ways:
Leverage: you start with an initial investment of R100 and use this to buy a futures contract with an effective exosure of R1000.
You have essentially put down a 10 percent deposit and are geared 10 times. Should the market on which
your future is based – say the all share index – go up by 25 percent, your contract would be worth R1250. So if you were to close your future contract your would show a net profit of R250.
But should the market fall 25 percent, your future contact will be worth onlyl R750, resulting in you having to pay in an extra R250 – in effect losing R250.