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Sunday August 07 2022
Barriers To SA Investors: Exchange Controls, Tight Unit Trust Rules and High Tax Act As Disincentives to Setting Up Funds Locally

Financial Mail  November 28, 1997

by Sharon Wood


Exchange controls, tight unit trust rules and high tax act as disincentives to setting up funds locally



A household name in the rest of the developed world, hedge funds are just finding their way into the collective investment mind in SA.


But exchange controls still impose tight restrictions on possible SA involvement in these products because of the large minimum entry requirements and, more importantly, the fact that there are as yet no locally domiciled hedge funds.


Hedge funds tend to set up in tax havens around the world to avoid corporate tax eating into their returns and to circumnavigate regulations governing mutual funds. The disadvantages of offshore funds are the lack of protection offered by international tax treaties, and because of the lack of regulation of funds, they are not always marketable to investors.


Easing local restrictions on establishing certain forms of hedge funds in SA would mean that fund managers could counteract the impact of rand depreciation on returns, and the product would be easily accessible to investors.


Standard Bank's London office has run a hedge fund since late 1995 and the returns have substantially outperformed the JSE All Share and the Financial and Industrial indices. In the middle of this year, the fund notched up returns of almost 100% compared with returns that were only slightly positive on the other two indices.


But Standard Bank Hedge Fund spokesman Adrian Dofay says the product is primarily taken up by US investors and is not marketed to the SA audience. The minimum investment is a hefty US$250 000. He says the group has only thought about launching an SA-based product. "It would be a lot easier if the product was domiciled in SA because we wouldn't have to contend with the dollar/rand exchange rate. It is more difficult to generate positive returns for shareholders if the rand is down as it has been this year."


This week BOE and Magnum Funds jointly announced they would set up an SA hedge fund in January that would be based offshore with a minimum investment of $100 000. BOE portfolio manager Chris Logan says: "We would love to launch a product locally, but the biggest impediments are that profits are taxed at the normal company rate and unit trust regulations are too restrictive."


Current unit trust regulations do not allow funds to short the market (the practice of borrowing scrip and selling on the assumption that the price of the instrument will fall in the future). The regulations also limit a fund's exposure to derivative instruments. A fund manager may not have more than 20% of the total fund tied up in derivatives, which virtually rules out using hedging and leveraging strategies.


Hedge funds come in all shapes and sizes, and make varied use of derivative strategies. Magnum Fund Management chairman Dion Friedland says a popular misconception is all hedge funds are volatile: "Less than 5% of hedge funds are global macro funds, like George Soros's Quantum Fund. Most hedge funds use derivatives only for hedging or don't use derivatives at all; many use no leverage."


Magnum/BOE cannot operate from SA as a unit trust because it may not short sell scrip. Otherwise, it does not plan to make heavy use of derivatives and will focus on its core competence of being able to find relative share performance opportunities and capitalise on a view by pursuing a long/short strategy.


Logan uses an example - to illustrate the potential returns - the long/short scenario this year with Standard Bank and Nedcor shares.


Returns of 137,1% would have been delivered if Standard Bank shares had been sold short and Nedcor shares had been bought with the funding raised by the short leg of the transaction.


Financial Services Board (FSB)'s Rob Barrow, who is deputy executive officer for investment institutions, says the board is not considering dropping this ruling because the industry has not made representation on the issue. But he says the Association of Unit Trusts and the FSB are looking into lifting the 20% "conservative" ceiling on derivative investment. "The current restriction was brought in about five years ago when derivatives were new. The board was concerned then about creating too high a risk for the man in the street and went for the conservative limit. But that is being relooked at."


He sees the issue being resolved "sometime next year."


On the tax issue, Barrow says the board doesn't set tax policy and suggests that industry make representations to the Finance Department on the issue that full company tax must be paid on the proceeds of open-ended funds.

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