novare hedge fund survey

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NOVARE® INVESTMENTS . SOUTH AFRICAN HEDGE FUND SURVEY 2012 . PAGE 1

OVERVIEW 2ASSET LEVELS 3 Fund launches and closures 6 Capacity 7 Industry opinion: Sources of asset growth 7PERFORMANCE 8 TRACK RECORD 11STRATEGIES 12 STRUCTURE 14INVESTORS AND FEES 15 Investor profile 15 Dealing frequency 16 Fees 18OPERATIONS 21 Fund audit 21 Fund valuation and client administration 22 Risk monitoring and compliance 23 Prime broker 25PORTFOLIO HOLDINGS AND TRADING ACTIVITY 26RISK LEVELS 29 Equity long/short 29 Equity market neutral 30 Other equity centric strategies 31 Fixed interest hedge 32CLOSING REMARKS 33CONTACT US 34 Disclaimer 34

OVERVIEW


A cursory overview of this year’s Novare® Investments South African Hedge Fund Survey might mistakenly lead one to conclude that there were no dramatic changes underlying the data. In fact, the industry underwent some material changes in a tumultuous year when financial markets produced some rather interesting and varying results, and when substantial regulatory change became imminent.

Despite an ever changing landscape, the industry continued to mature and even managed to position itself ahead of international peers with regard to certain pertinent aspects of best practice.

Some of the key findings:

• Industry assets reached an all-time high of R33.6 billion;

• Continued shift towards managers with a larger hedge fund asset base;

• Managers with hedge fund assets exceeding R2 billion represent 46.2% of industry assets;

• More than R1.5 billion of new inflows were allocated to hedge funds with between R1

billion and R2 billion in assets under management;

• 14 new hedge funds were launched;

• The majority of industry assets are housed in hedge funds with a track record longer than

five years;

• The equity long/short strategy continued to dominate the local market;

• Participants managing 99.1% of industry assets are authorised Category IIA Financial

Services Providers.

The report elaborates on some of the implications of these and other findings from the latest industry surveys.

This survey is conducted by means of a questionnaire sent to managers who classify themselves as managing hedge funds. This year we received responses from 62 managers who collectively manage in excess of 106 different mandated funds.

The survey takes an industry snapshot as at 30 June 2012 and offers commentary on trends observed over the 12 months ending June 2012. This edition marks the ninth edition of the Novare® Investments South African Hedge Fund Survey.

ASSET LEVELS


Local hedge fund industry assets reached R33.6 billion in June 2012, an all-time high and an increase of 6.9% from June 2011. This represents a 10.9% increase over the R30.3 billion asset level achieved in June 2008 when assets first rose above R30 billion.

The increase in assets came mainly from participating funds’ performance over the past year rather than capital flows. New capital inflows remained relatively muted during the past 12 months, with participants indicating net inflows of only R461 million (this value excludes funds that returned capital to investors due to being wound down).

INDUSTRY ASSETS AND NET ASSET FLOWS

Unpacking the numbers shows there has been a clear shift towards the larger hedge fund managers. In particular, asset managers with between R1 billion and R2 billion in hedge fund assets under management have received the lion’s share of new inflows, amounting to more than R1.5 billion of capital inflows.

As at June 2012, hedge funds managing over R2 billion across all their hedge fund products represented 46.2% of industry assets, a significant increase from 33.7% in 2011 and 23.2% in 2010.

In addition there were 14 hedge fund managers in South Africa managing hedge fund capital exceeding R1 billion compared to 11 a year ago. The majority of these (78.6% of managers) were boutique hedge fund managers as opposed to large (long only) asset management houses with hedge fund offerings.

R 1 388R 2 125

R 3 286

R 6 068

R 15 361

R 25 895

R 30 274R 29 434

R 32 096 R 31 433

R 33 595

-R 2 000

R 0

R 2 000

R 4 000

R 6 000

R 8 000

R 10 000

R0

R5 000

R10 000

R15 000

R20 000

R25 000

R30 000

R35 000

R40 000

Jun'02 Jun'03 Jun'04 Jun'05 Jun'06 Jun'07 Jun'08 Jun'09 Jun'10 Jun'11 Jun'12

Net cash flows (R million)Industry assets (R million)

Total assets (left axis) Net cashflows (right axis)


Hedge fund managers managing capital between R500 million and R1 billion represented 4.0% of industry assets, significantly down from 20.0% a year ago. Three managers that had between R500 million and R1 billion under management a year ago attracted more capital and moved into the R1 billion group, whereas a number of managers from last year’s R500 million to R1 billion group suffered redemptions.

Assets in the R200 million to R500 million group also increased and now represent 10.7% of the industry.

DISTRIBUTION OF INDUSTRY ASSETS

4.1% 8.1% 10.0%

14.8%11.3%

13.3%

13.0% 14.5% 3.3%

8.7%14.5%

18.3%

17.4%11.3%

11.7%

42.0% 40.3% 43.3%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

2010 2011 2012

% of hedge fund managers

23.2%

33.7%

46.2%

42.8%32.0%

32.9%

20.3% 20.0%

4.0%

5.9% 8.9% 10.7%

5.0% 2.9% 3.2%2.8% 2.5% 3.1%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

2010 2011 2012

% of industry assets

> R2 billion R1 to R2 billion R500 million to R1 billion R200 to R500 million R100 to R200 million < R100 million


On average, the group of managers with assets exceeding R2 billion received a marginal amount of new capital, but a closer look reveals that a subset of these suffered net outflows with different managers within this category being the recipients of flows. Managers with assets under management exceeding R1 billion (less than R2 billion) raised assets faster than smaller funds. Net asset inflows into these hedge funds exceeded R1.5 billion.

Asset managers with hedge fund assets of between R500 million and R1 billion had net capital outflows of approximately R100 million. Similarly, funds with assets between R200 million and R500 million had net outflows in excess of R350 million.

Interestingly, fund managers with hedge fund assets between R100 million and R200 million were net receivers of capital during the 12 months to June 2012.

Fund managers with less than R100 million of hedge fund assets under management continued to lose money, with net outflows exceeding R350 million. However, for most of these managers hedge funds were not their only product or service offering.

ASSET FLOW BREAKDOWN BY ASSETS UNDER MANAGEMENT

-R 2 000

-R 1 500

-R 1 000

-R 500

R 0

R 500

R 1 000

R 1 500

R 2 000

> R2 billion R1 to R2 billion R500 million to R1 billion R200 to R500 million R100 to R200 million < R100 million

Net asset flow (R million)

Company hedge fund AUM

Jun'11 Jun'12


On a strategy basis equity long/short hedge fund managers were the largest net recipients of capital in the industry with most of the other strategies losing capital on a net basis.

ASSET FLOW BREAKDOWN PER STRATEGY

A total of 14 new hedge funds were launched between 1 July 2011 and 30 June 2012. Ten of these were launched by companies that already manage hedge funds.

The bulk of the new funds were equity long/short funds (with a variable bias) and the average assets in the new funds were R50 million.

Funds-of-funds were again the largest supporters of new funds. Seeding capital constituted about 16.7% of assets. Life funds contributed a further 10.2% of new capital received in start-ups.

In addition, 14 funds returned investor capital during the 12 months leading up to June 2012, six of these being equity market neutral funds. These funds in aggregate housed approximately R1 billion as at 30 June 2011.

Fund launches and closures

-R 2 000

-R 1 500

-R 1 000

-R 500

R 0

R 500

R 1 000

R 1 500

R 2 000

Equity long/short Equity market neutral Fixed interest hedge Multi-strategy

Net asset flow (R million)

Jun'11 Jun'12


Hedge fund managers often close their funds when they reach a certain level of assets under management, mainly due to profitable investment opportunities being better exploited by a smaller, more nimble fund. Depending on the strategy and the manager’s preferences, capacity could be constrained. A mere 7.6% of managers indicated that their funds were hard closed for investments (representing 10.1% of industry assets). The bulk of these funds were equity long/short funds.

Another 6.7% of funds were soft closed (taking only additional capital from current investors). These funds housed 14.9% of industry assets and were mainly equity long/short funds.

Participating managers whose funds were still open for new investments indicated total available capacity of at least R45 billion.

INDUSTRY POLL: ORGANIC ASSET GROWTH

Where do hedge fund managers expect the new wave of organic growth to originate from? This question was posed to the participants, with the following options: • Pension funds investing via funds-of-funds;• Pension funds investing directly;• Retail investors into CISCA-regulated hedge funds;• Foreign investors;• Net outflows expected.

Of the participants 53.8% indicated new capital would be allocated via funds-of-funds. Another 18.3% were of the opinion that direct pension fund allocations would lead to the next phase of organic growth, followed by foreign investor allocations at 14.4%. Of the participants, 7.7% held the view that the next phase of growth would come via investments through a CISCA regulated struc-ture.

Capacity

Industry opinion: Sources of asset growth

53.8%

18.3%

7.7%

14.4%

5.8%

0%

10%

20%

30%

40%

50%

60%

Funds-of-funds Pension funds CISCA structure Foreign investors Net outflows

PERFORMANCE


The local hedge fund industry held up well over the past year, with strong performances especially from the fixed interest and multi-strategy funds.

Local hedge funds suffered lower drawdowns in the third quarter of 2011 when compared to the FTSE/JSE All Share Index that was down nearly 6.0%. In addition, South African hedge funds achieved strong returns with considerably less volatility than observed in the long only market supporting the notion that hedge funds offer an attractive risk-return profile.

QUARTERLY RETURN DISPERSION

-60%

-40%

-20%

0%

20%

40%

60%

80%

Jun'02 Dec'02 Jun'03 Dec'03 Jun'04 Dec'04 Jun'05 Dec'05 Jun'06 Dec'06 Jun'07 Dec'07 Jun'08 Dec'08 Jun'09 Dec'09 Jun'10 Dec'10 Jun'11 Dec'11 Jun'12

Average hedge fund return FTSE/JSE All Share index


The strongest performing hedge funds during the 12 months leading up to June 2012 were funds with a larger asset base. The following results are asset weighted returns for this period:

• Hedge funds with assets under management exceeding R1 billion (representing 34.9% of industry assets) delivered an average return of 16.1%;• Funds with assets of between R500 million and R1 billion (29.1% of industry assets) delivered 12.8%;• Funds with R200 million to R500 million (26.0% of assets) delivered 13.4%;• Funds with R100 million to R200 million (6.1% of assets) delivered 11.1%;• Funds with less than R100 million (4.0% of assets) delivered 7.8%.

AVERAGE PERFORMANCE BY FUND SIZE

The above results are interesting in as much as they are counterintuitive relative to the general assumption that smaller funds should be better placed to exploit market inefficiencies and thus be outperforming their larger peers. Given the size of the South African hedge fund market relative to overall market capitalisation however, it seems as if the larger funds in South Africa are not suffering from this size bias – in the contrary they may actually be benefitting from certain intellectual and operational economies of scale.

16.1%

12.8%13.4%

11.1%

7.8%

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

0%

5%

10%

15%

20%

25%

30%

35%

40%

> R1 billion R500 million to R1 billion R200 million to R500 million R100 million to R200 million < R100 million

% return% assets under management

% AUM (left axis) 12 month return to Jun'12 (right axis)


The different hedge fund strategies yielded a wide dispersion of performances over the 12 months ending June 2012. The following results are asset weighted returns for the respective strategies observed during this time frame:

• Fixed interest hedge funds delivered 18.0% for the year. Manager returns ranged between 2.2% and 44.9% for the 12 months, illustrating the relative dispersion that was observed.• Equity market neutral funds delivered returns of between -11.8% and 24.1% with the strategy returning a mere 4.9%. Difficulties faced by the strategy include operating in a low interest rate environment. • A return of 16.0% was achieved by the equity long/short strategy.• Multi-strategy delivered returns exceeding 16.8% for the 12 months .

MANAGER AND ASSET WEIGHTED RETURN PER STRATEGY

18.0%

4.9%

16.1% 16.8%

-20%

-10%

0%

10%

20%

30%

40%

50%

60%

% return

12 month manager return to Jun'12 12 month asset weighted return to Jun'12

Fixed interest hedge Equity market neutral Equity long/short Multi-strategy

TRACK RECORD


The broader trend, as confirmed by investors, is a continued emphasis on track record and experience. This is evidenced by the fact that around 70.0% of industry capital is allocated to funds with four or more years’ track record, which also represents over 50.0% of all funds in existence locally.

An alternative interpretation of this data would be that risk appetite post 2008, combined with a difficult market environment in which to raise new assets, limited the opening of a more meaningful number of new fund start-ups. The latter argument is contrasted by the fact that just under 30.0% of funds in the industry have a track record of two years or less. The graph below illustrates the percentage of funds with a minimum track record as specified.

LENGTH OF TRACK RECORD

2.6%

14.3%

6.2%

15.2%

7.3%

9.5%

14.4%

9.5%

10.3%

10.5%

8.7%

9.5%

18.7%

12.4%

31.8%

19.0%

0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%

% assets under management

% funds

1 year 2 year 3 year 4 year 5 year 6 year 7 year > 8 years

STRATEGIES


The equity long/short strategy continued to dominate the local hedge fund market, gaining market share from 12 months earlier and representing 44.9% of assets (compared to 37.7% of assets 12 months prior). Fixed interest hedge was comfortably the second largest strategy in the country, even though its market share remained similar to last year.

The equity market neutral strategy continued losing market share on the back of poor relative performance, investor redemptions and fund closures. Investors continued to reallocate investments away from equity market neutral, with significant increases in allocations to equity long/short.

As of June 2012, fixed interest hedge funds represented 19.1% (19.3% in 2011) and equity market neutral 14.4% (down from 18.0% in 2011) of aggregate industry assets.

Multi-strategy hedge funds represented 10.1% of industry assets compared to 7.7% a year ago.

Volatility arbitrage funds represented 4.0%, in line with their market share during 2011.

Structured finance funds constituted 1.2% of industry assets compared to 2.1% in 2011. The drop was mainly due to funds returning investor capital.

ASSETS BREAKDOWN BY STRATEGY

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Jun'04 Jun'05 Jun'06 Jun'07 Jun'08 Jun'09 Jun'10 Jun'11 Jun'12

Equity long/short Fixed interest hedge Equity market neutral Multi-strategy Volatility aribitrage Structured finance Other strategies


For the purpose of the survey the equity long/short strategy was subdivided between funds with a long bias and funds with a variable bias. These represent 34.7% and 10.2% respectively of industry assets.

Similarly, fixed interest hedge was also sub-divided between fixed interest arbitrage funds (relative value funds) and fixed interest long/short. These funds represented 10.7% and 8.4% respectively of industry assets as at 30 June 2012.

ASSETS BREAKDOWN BY SUB-STRATEGY

3.4% 4.3%8.4%

12.2%

15.0%10.7%

2010 2011 2012

Fixed interest long/short Fixed interest arbitrage

33.8%

27.4%

34.7%

8.1%

10.3%

10.2%

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

50%

2010 2011 2012

Equity long/short - long bias Equity long/short - variable bias

STRUCTURE


The most popular investment vehicle or structure to house South African hedge fund assets remained the en commandite partnership with 53.7% of industry assets. This was a marked increase from last year, when 45.7% of industry assets were housed in this structure. This was followed by the debenture/trust structure with 37.2%. Other methods used to house industry assets included segregated portfolios, equity linked structures, life policies and note structures.

The increase in assets in en commandite partnerships was due to new inflows. In addition, nine of the newly launched funds were en commandite partnerships with the remainder using a debenture structure.

INVESTMENT STRUCTURE | VEHICLE

43.1% 45.7%53.7%

30.2%

36.7%

37.2%

26.7%17.6%

9.1%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Jun'10 Jun'11 Jun'12


En commandite partnership Debenture structure Other

INVESTORS AND FEES


The largest allocator of capital to the South African hedge fund industry remained funds-of-funds which held 66.3% of capital as of 30 June 2012. The second largest group invested in local hedge funds were high net worth individuals and retail clients at 15.7% of industry assets. This represented an approximate 50.0% increase from 12 months earlier. Pension funds and life funds held approximately equal amounts with the remaining capital being either seeding or proprietary capital.

INVESTOR TYPE

Investor profile

The low number of pension funds investing directly in hedge funds should be a concern, as most commentators expected an increase in allocations from pension funds following Regulation 28 (Reg28) developments.

Pension fund investors who had invested in hedge funds prior to the Reg28 amendments might have had more exposure than the new maximum of 10.0% promulgated in the revised Reg28 and had to reduce their allocations to comply. It also indicates that there was not a large uptake by pension funds that had not been invested before to invest in hedge funds following clarity on Reg28.

64.8% 66.6% 66.3%

12.4% 10.4%15.7%

9.2%5.2%

5.8%

8.6%10.3%

6.6%

0.0% 6.3% 5.4%5.1% 1.1% 0.1%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%


% assets under managment

Funds-of-funds High net worth individuals/Retail Pension funds Life funds Seeding/Proprietary Other


The norm remained for monthly investor subscription and redemption as indicated by 98.4% of participants. Interestingly, the results indicate a large decline in the assets represented by funds that allow only quarterly dealing – down from 6.3% to almost zero. Also, funds representing 1.5% of assets allowed daily investor dealing, a decrease from 4.2%.

INVESTOR DEALING FREQUENCY

Dealing frequency

The bulk of industry assets (72.5%) required a 30 day redemption notice period to redeem capital from funds. Far fewer funds accommodated redemptions with less than 30 days’ notice – down from 6.1% of assets to 0.6%. All new start-ups also required a 30 day redemption notice period.

6.3% 4.2% 1.5%

0.9% 0.5%

81.7% 89.0% 98.4%

11.0%6.3%

0.0%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%



Daily Weekly Monthly Quarterly

INVESTOR REDEMPTION NOTICE PERIOD

7.2% 6.1%0.6%

70.6%63.9% 72.5%

0.6%

3.9%2.7%

17.8% 24.1% 23.1%

3.8% 2.0% 1.0%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%



< 30 days 30 Days 60 Days 90 Days > 90 days


A mere 0.3% of industry assets were subject to a lock up period of one year or longer. Fund managers responsible for 98.2% of industry assets indicated that no lock up period applied.

INITIAL INVESTMENT LOCK-UP PERIOD

In the following section the questionnare requested participants to indicate whether certain redemption provisions or restrictions applied to their funds as determined by their investor terms and conditions. In line with results from previous surveys, only a few local hedge funds applied such provisions.

Weighted by asset size, the results were as follows:

• 10.8% of industry assets are subject to a redemption penalty;• 8.0% of assets are subject to side pocketing;• 26.2% of assets are subject to certain suspension provisions as stipulated in their investor terms and conditions;• 16.8% are subject to in specie redemption;• To 19.7% of assets gating may apply;• 18.6% of assets may be subject to ring-fencing.

92.1% 93.7%98.2%

5.3% 4.8% 0.6%0.0% 1.2% 1.0%2.6% 0.4% 0.3%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%



None 3 months 6 months > 1 year


The asset-weighted average management fee charged by South African hedge funds is 1.1%.

The industry norm, applicable to 69.4% of assets, remained an annual management fee of 1.0%.

All of the fixed interest hedge fund managers participating in this year’s survey charged 1.0% per annum.

The bulk of strategies that charged 2.0% per annum were multi-strategy, commodity hedge funds and structured finance funds.

MANAGEMENT FEES CHARGED PER ANNUM

Six of the 14 new funds launched during the year charged a management fee of 1.0%, followed by four funds with a management fee of 1.5% and four funds charging 2.0%.

Fees

0.3%4.6% 5.2%

8.8% 0.0% 0.0%

67.9%73.1% 69.4%

17.9% 15.5%15.5%

5.1% 6.8% 9.8%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%



0.0% 0.50% - 1.0% 1.0% 1.5% 2.0%


The bulk of industry assets (91.9%) are subject to a performance fee of 20.0% (this is also the highest performance fee charged); another 7.6% of assets are subject to a performance fee of between 15.0% and 20.0%. Assets subject to a performance fee of 10.0% accounted for only 0.5% of industry assets (down from 3.5% from the previous survey period).

PERFORMANCE FEES

The most popular hurdle from which performance fees are taken remain cash as indicated by funds managing 73.6% of industry assets. Assets subject to performance fees being taken on all positive performance amount to 14.9% of industry assets, similar to 12 months earlier.

HURDLE RATE USED FOR PERFORMANCE FEE CALCULATIONS

3.8% 3.5% 0.5%

10.9%3.5% 7.6%

84.6%93.0% 91.9%

0.6% 0.0% 0.0%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%



10.0% 15.0% - 20.0% 20.0% 25.0%

15.7% 14.9% 14.9%

63.5%72.2% 73.6%

6.3%

7.8% 5.2%3.6%

2.4% 2.3%9.0%

2.8% 3.9%2.1%0.0% 0.0%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%



No hurdle Cash Cash + fixed hurdle Inflation Inflation + fixed hurdle Other


The majority of hedge funds (47.7% of industry assets) calculated the performance fee only on the portion by which performance surpassed the hurdle (outperformance method), compared to 48.8% a year earlier. A further 37.7% of assets were subject to performance fees charged from zero, but subject to the investor receiving at least a return equal to the hurdle rate (accelerated performance fee, or trigger hurdle method). In 2011, 38.4% of assets were subject to this methodol-ogy. The remaining assets took performance fees on all performance.

Most participants indicated crystallisation of performance fees on an annual basis (44.7% of industry assets, slightly up from 40.6%). The next most popular crystallisation period was quarterly, as indicated by funds managing 38.4% of assets.

The number of funds for which performance fee crystallisation takes place every six months remained relatively unchanged at 15.1%. The trend of extending the performance fee crystallisation period is also evident from the reduction in assets represented by funds charging a monthly performance fee – down from 4.6% to 1.8%.

PERFORMANCE FEE CRYSTALLISATION

5.00% 4.6% 1.8%

46.4%39.5%

38.4%

12.2%

15.3%15.1%

36.3%40.6%

44.7%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%



Monthly Quarterly 6-monthly Annually


The hurdle rate used for performance fee calculations usually resets at the time of the payment of performance fees. However, some funds also reset the performance fee hurdle annually in addition to resetting upon performance fee crystallisation. 74.8% of industry assets are subject to the reset of the hurdle only when performance fees crystallised. Annual reset occurred for 17.0% of industry assets, a slight increase from the year before.

PERFORMANCE FEE HURDLE RESET

OPERATIONS

A more stringent operating environment has been recognised by local hedge fund managers as well as new entrants to the market. Operational aspects associated with hedge funds include non-investment related functions such as the fund audit, client reporting and compliance monitoring.

Fund audit

All participants have indicated that their funds are subject to an annual fund audit by an external service provider. In addition, for 2.9% of assets the fund audit function is undertaken on both an in-house and outsourced basis. No local hedge fund uses only an in-house fund audit function.

12.3% 13.7%7.7%

65.1% 66.0% 74.8%

15.6%15.6%

17.0%

2.4% 4.7%0.6%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%



No hurdle Upon payment of performance fee only Upon payment of performance fee or annually Other


It has become industry norm to have an independent administrator value the fund, as participants overseeing 99.9% of industry assets use an independent administrator for the fund valuation (within this, for 65.3% of industry assets the fund valuation is solely outsourced and for 34.6% this function is outsourced in combination with being confirmed in-house).

For just over half of industry assets client reporting is outsourced, with another 40.1% subject to a combination of in-house and outsourcing and funds representing 6.7% of assets performing this function in-house only.

Client administration is also mainly performed by an independent outsourced service provider with 67.8% of industry assets following this route, 25.6% performing this function in-house in combination with outsourcing, and participants managing 6.7% of industry assets indicating this function is performed in-house only.

FUND VALUATION AND CLIENT ADMINISTRATION

Fund valuation and client administration

65.3%

53.3%

67.8%

34.6%

40.1%

25.6%

0.1%

6.7%

6.7%

0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%

Fund valuation

Client reporting

Client administration

Outsourced Outsourced and in-house In-house


FREQUENCY OF NAV REPORTING

Risk management and compliance

Of all participating asset managers, 99.1% have a Financial Services Board (FSB) CAT II A license or are a licensed representative under another FSP’s license. This license is a requirement for managing hedge fund capital in South Africa. It should be mentioned that the one participant that does not have a license is in the process of applying for a license and is currently only managing internal proprietary capital.

Fund managers responsible for 91.8% of industry assets trade under their own managing company’s license, with the remaining capital being managed by authorised representatives under another company’s license.

Reporting requirements for this are outsourced by 34.3% of industry assets, 26.8% of assets perform this function in-house and the remaining outsource the function as well as monitor it in-house.

An interesting observation was the move towards weekly NAV reporting to investors, compared to previous years when more funds opted for daily reporting. Broken down by assets under management, funds offering their investors daily soft NAV reporting reduced to 37.7% from 43.0% a year ago. Funds reporting a weekly NAV increased from 18.5% in 2011 to 30.6%.

Funds representing 29.0% of industry assets reported their NAVs on a monthly basis only, and funds housing 2.8% of industry assets report a NAV on a biweekly basis. This year there were no funds that reported NAV to investors on a quarterly basis only.

40.6% 43.0%37.7%

15.8%18.5% 30.6%

0.0%

0.0%

2.8%

39.8%37.4%

29.0%

3.8% 1.1% 0.0%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%



Daily Weekly Biweekly Monthly Quarterly

Risk monitoring and compliance

8.1%

19.0%11.1%

52.2%

52.1%63.4%

39.7%

28.9% 25.4%

0%

10%

20%

30%

40%

50%

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70%

80%

90%

100%



Outsourced In-house and outsourced In-house


MANDATE COMPLIANCE MONITORING

Similar to mandate compliance monitoring the function of portfolio risk monitoring is increasingly being performed both internally and externally with 63.4% of industry assets following this route (compared to 52.1% at June 2011). Funds for which risk monitoring is done by an external party only, almost halved to 11.1%. Funds representing 25.4% of the industry perform risk monitoring in-house only.

Interestingly, more managers are performing the portfolio mandate compliance monitoring function internally in combination with outsourcing as indicated by funds representing 63.2% of industry assets (up from 49.6% last year). For 20.8% of assets, the mandate compliance monitoring function is done internally only, with 15.9% of funds subject to mandate compliance monitoring by an external party only.

PORTFOLIO RISK MONITORING

33.2%27.7%

15.9%

38.8% 49.6%

63.2%

27.9%22.7% 20.8%

0%

10%

20%

30%

40%

50%

60%

70%

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100%



Outsourced In-house and outsourced In-house


PRIME BROKER

A noticeable observation was the reduction in the number of funds utilising more than one prime broker. This was in contrast with overseas trends where hedge funds are moving towards a multiple prime broker approach in the wake of the Lehman collapse in 2008. Local industry assets using more than one prime broker reduced to a mere 2.8% of assets, compared to 7.8% in June 2011 and 5.7% in June 2010. Most managers (81.6% of assets compared to 73.7% in June 2011) use a single prime broker.

It should be mentioned that the 15.6% of assets not using a prime broker were housed within larger asset managers with an established dealing desk.

All of the new funds launched indicated that they had an appointed prime broker.

Prime broker

73.0% 73.7%81.6%

5.7% 7.8%

2.8%

20.9% 18.6% 15.6%

0%

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Yes More than one No


PORTFOLIO HOLDINGS TRANSPARENCY

South African hedge funds that allowed investors viewing access to the portfolio holdings on a daily basis increased to 59.9%, compared to 53.4% 12 months earlier. Assets representing 30.6% of the industry allowed investors portfolio transparency on a monthly basis, compared to 36.8% in 2011.

Viewing of actual holdings on a quarterly basis remained unchanged at 1.3%. Allowing investors to view holdings on an occasional basis (with a lag) went from 5.9% to 7.8%, as funds with this policy grew assets from a year earlier. Funds that did not reveal their actual portfolios to investors reduced to a mere 0.3%.

PORTFOLIO HOLDINGS AND TRADING ACTIVITY

52.8% 53.4%59.9%

3.8% 0.8%

0.1%

29.0% 36.8%30.6%

3.4%1.3% 1.3%

6.5%5.9% 7.8%

4.6% 1.8%0.3%

0%

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30%

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100%



Actual holdings daily Actual holdings weekly Actual holdings monthly Actual holdings quarterly Occasionally, with a lag None


TRADING ACTIVITY

The following indicates that hedge fund managers traded their portfolios less frequently over the past year.

• 29.10% of assets where traded less than once the portfolio NAV (compared to 13.1% in 2011). All volatility arbitrage funds and the bulk of equity long/short funds with a variable bias indicated this;• Portfolio turnover of one to two times NAV remained relatively stable at 12.3% (12.7% in 2011);• Trading activity of two to three times NAV was indicated by 24.1% of assets (more than half of equity long/short managers indicated this);• Industry assets that were traded three to five times NAV increased to 13.2% compared to 3.5% in 2011;• Assets that were traded five to ten times NAV dropped to 3.6% compared to 26.6% in 2011;• Fewer managers (17.7% of industry assets compared to 21.8% in 2011) indicated that their portfolio trading activity increased to more than ten times NAV last year. Most of the fixed interest hedge funds and equity market neutral hedge funds fall into this category.

0%

10%

20%

30%

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50%

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70%

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100%

Jun'07 Jun'08 Jun'09 Jun'10 Jun'11 Jun'12

0 - 1x 1x - 2x 2x - 3x 3x - 5x 5x - 10x more than 10x


LIQUIDATION OF UNDERLYING ASSETS

The time it takes to liquidate portfolio holdings has also seemingly increased. This could either be due to markets that seem to be more illiquid now than a year ago, or managers now investing more in illiquid holdings than they did last year.

On average, and in “normal” market conditions, in the year to June 2012 it would have taken:

• One day to liquidate 41.4% of industry assets (from 54.0% in 2011);• Five days to liquidate 24.6% of industry assets;• Ten days to liquidate 14.5% of industry assets; • 30 days to liquidate 9.0% of industry assets (from 5.6% in 2011);• 60 days to liquidate 4.3% of industry assets; • More than 60 days to liquidate the remainder, or 6.2% of industry assets.

0%

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40%

50%

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70%

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100%

Jun'08 Jun'09 Jun'10 Jun'11 Jun'12

1 day 5 days 10 days 30 days 60 days >60 days

A look at the breakdown by strategy reveals the following:

• Equity long/short managers indicated that 96.0% of their assets could be liquidated within 30 days;• Equity market neutral managers would be able to liquidate an estimated 99.1% of their holdings within 30 days;• Fixed interest managers would be able to liquidate an estimated 84.2% of their assets within 30 days; • Multi-strategy funds estimated that they could liquidate 83.7% of their assets within 30 days;• Commodity and volatility arbitrage strategies indicated they could liquidate 100.0% of their holdings within 30 days.


When considering an investment in hedge funds, various risk factors should be taken into account including leverage, illiquid underlying instruments and potentially higher fees, to name a few. Hedge fund FSPs (CATIIA licensees) must, in writing, disclose to clients the risks of hedge funds and those peculiar to a specific hedge fund portfolio, and ensure that clients understand the risk disclosures. The format of these risk disclosures is determined in the FSB’s Board Notice 571 of 2008 (the “Notice on Hedge Fund FSP Disclosures, 2008”). Even though not all of these factors are covered in the section that follows, this section is a good indication of the positioning of South African hedge fund managers and some of their more quantifiable risks and exposure levels.

RISK LEVELS

AVERAGE NET EQUITY EXPOSURE VS GROSS EXPOSURE (BUBBLE SIZE REPRESENTS AUM OF STRATEGY)

Equity long/short

Over the past year, equity long/short managers with a long bias maintained an average net exposure of 63.0% to the equity market (compared to 59.8% in 2011 and 46.3% in 2010) and an average gross exposure of 146.3% (133.2% in 2011 and 131.2% in 2010).

Equity long/short managers with a variable bias positioned their portfolios slightly more aggressively during the 12 months to June 2012 when considering average gross exposure which increased to approximately 300.0% (189.3% in 2011). However these funds’ average net equity exposure nearly halved from 20.7% to 11.9% in 2012.

2011 Equity long/short - long bias

2011 Equity long/short - variable bias





0%

50%

100%

150%

200%

250%

300%

350%

0% 10% 20% 30% 40% 50% 60% 70% 80%

Average gross exposure

Average net exposure

The bulk of assets had net equity exposure of less than 100.0% and gross exposure of less than twice the fund NAV.


True to their investment style equity market neutral managers maintained limited exposure to the equity market, but compared to a year before almost doubled their average net equity exposure from 7.5% (159.2% gross exposure) to an average of 14.7% (gross exposure of 132.6%) during the past 12 months.


Equity market neutral

The bulk of the strategy had average net equity exposure of less than 30.0% and gross exposure of less than two times NAV.

2011 Equity market neutral



125%

130%

135%

140%

145%

150%

155%

160%

0% 5% 10% 15% 20% 25% 30% 35% 40% 45% 50%




Other strategies that have exposure to the equity market include multi-strategy and volatility arbitrage.

On average, over the past 12 months multi-strategy had average equity market exposure of approximately 38.9% (compared to 21.7% in 2011) and average gross exposure of 131.9% (99.2% in 2011).

Over the past year, volatility arbitrage had average exposure of approximately 15.4% and gross exposure of 162.9% compared to 5.0% and 161.9% respectively during 2011.


Other equity centric strategies

2011 Multi-strategy

2011 Volatility arbitrage

2012 Multi-strategy


2010 Multi-strategy


0%

50%

100%

150%

200%

250%

300%

0% 10% 20% 30% 40% 50% 60% 70% 80%




Participating fixed interest hedge fund managers were questioned on which of the following risks they perceived to be the greatest in their portfolios (the higher the score, the greater the expected risk to the fund):

Fixed interest hedge

• The largest risk according to 70.6% of respondents was interest rate risk;• Fixed interest strategy assets indicated that the second largest risk was tilt or directional risk;• The third largest risks to portfolio assets were indicated as credit risk;• Most of the respondents indicated currency risk posed the least risk to their portfolios.

RISKS FACED BY FIXED INTEREST HEDGE FUNDS

1.6

2.1

2.6

3.6

0 1 2 3 4

Currency risk

Credit risk

Tilt or directional

Interest rate risk

Score out of 4


With international hedge fund assets reaching an all-time high, local hedge funds witnessed surprisingly low new inflows, with most of the increase in assets under management attributable to performance. The net capital flows that did occur were allocated to larger (assets under management) and more established (length of track record) hedge fund managers.

Despite this, fund managers reinforced their investment case by focusing on the core business of fund management, while increasingly outsourcing non-investment functions such as fund administration to independent third parties. This year’s survey likely marks the last in which the hedge fund industry will operate in its current form, with speculation rife that regulators are on the brink of also bringing hedge fund products into the regulatory framework. Currently hedge fund managers are required to obtain a licence as a hedge fund manager but the products themselves are not yet formally regulated.

Product regulation will mark the official entry of hedge funds into mainstream finance and asset management within South Africa, not only building upon hedge funds’ recent inclusion within pension fund regulation, but importantly also potentially providing much needed regulatory clarity which industry participants and asset allocators alike have long hoped for.

Of course, the industry will be most interested in the impact this will have on future asset flows. Rather than being subject to a surge, asset flows are more likely to enjoy a slow, persistent turning of the tide.

CLOSING REMARKS

1

Novare® Investments (Pty) LtdThird Floor, The Cliffs Office Block 1Niagara Way | Tyger FallsCarl Cronje Drive | Bellville | 7530South Africa

P O Box 4742Tyger Valley | 7536South Africa

Tel: +27 (0) 21 914 7730Fax: + 27 (0) 21 914 [email protected]

www.novare.com

Authorised Financial Services Provider: 757

D I S C L A I M E RThis survey report is for the use of Novare® and its clients and may not be

published externally without written permission obtained from Novare®

([email protected]). The information in this survey report is for general

guidance and does not constitute the personal views of Novare® nor an offer

made by Novare®. We have made every effort to ensure that the information

contained in this survey report is accurate. However, Novare® will not accept

any liability for losses suffered as a result of inaccuracies. This document is for

information purposes only and is not intended for the solicitation of new

business.

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