ALTERNATIVES - Into South Africa

A homegrown hedge fund industry is betting on the country’s increasing economic diversity.

In advance of hard times, investors once looked to South Africa as the hot spot for gold. And clearly, South Africa — which accounts for about 11 percent of the world’s gold production — has been a big beneficiary of the huge run-up in the price of the precious metal. But Africa’s largest economy is far more diverse these days, and the country’s homegrown hedge fund business is betting on a host of newer industries, including textiles, electronics and financial services.

“We invest largely in the financial field,” says Carl Isernhinke, chief investment officer of Cape Town–based Clade Investment Management, noting that his firm does not focus on mining, the industry for which South Africa has been traditionally known.

Clade — established in 2005 by Carl Liebenberg as an offshoot of Catalyst Innovation (founded in 1997) — started with only 30 million rand ($4.3 million). Clade Investment’s parent company, Clade Group, has R8 billion in assets under management and has garnered attention for its South African investable hedge fund index, which invests in 34 domestic funds.

The index returned 12.66 percent in 2007, says Isernhinke, who designed derivatives-based investment products at Escher Structured Products and held a similar post at Abvest Associates before joining Clade three years ago.

Clade offers a line of structured products tied to the index. Investment comes mostly from South African institutions. Funds of funds provide the majority of the backing; insurers and pension funds are smaller players. The index breaks out its components by strategy: 57 percent of assets under management are long-short equities, and the remainder are a mix of market-neutral, fixed-interest and quantitative plays.

It is a conservative approach born of government-imposed exchange controls introduced in World War II and strengthened during the country’s debt crisis in 1985 and again during the advent of majority rule in 1994. The restrictions limit hedge funds mostly to long-short investing, though in February allowances were made for trades in currency-future options. The rules also prevent South African hedge funds from investing more than 30 percent of their capital outside the country; that figure is expected to increase gradually, however. Historically, the government has done little else to regulate the hedge fund industry, but that may be changing in the wake of a hometown scandal. Cape Town–based Evercrest Capital made a bad bet shorting the stock of South Africa’s largest insurer, Sanlam, in April 2007 and lost R132 million, or almost two thirds of its value. Rules were promptly enacted requiring minimum levels of experience and education for hedge fund managers.

According to Cape Town–based portfolio management firm Novare Investments (R4.7 billion in assets under management), total hedge fund assets grew by 68.6 percent, to R25.9 billion, from June 2006 to June 2007, as the number of funds increased from 90 to 131. Novare, which was founded in 2000 and has an auxiliary office devoted to investment in Botswana and a pension manager contract with the government there (Botswana has one of the world’s highest per capita income growth rates), reports that the ten largest funds manage 40 percent of total assets.

A niche for funds targeting socially responsible investing arose from the end of apartheid in 1994. South African companies that want to do business with the government — the biggest single consumer in any country — must be designated Black Economic Empowerment enterprises, or BEEs, which means they must be at least 25.1 percent black-owned. “When we buy equity in a company, we give that company BEE status,” explains Zuko Kubukeli, executive director of Johannesburg-based Pan-African Capital Holdings, a black-owned investment management company affiliated with Rand Merchant Bank. Kubukeli says that 18 percent of the capital behind his firm’s R2.5 billion in assets under management was raised abroad from development banks and “families of conscientious investors.”

Yorkville Advisors of Jersey City, New Jersey, is among the foreign hedge funds angling for entry into the market as it negotiates for a stake in a South African financial services firm that specializes in making small-business loans.

Antony Ghee, a Yorkville associate managing director, notes two major differences between the hedge fund industry in the U.S. and in South Africa: “It’s certainly not as liquid as the U.S. market. And there’s a heavy institutional space — not as much retail trading.”