Hedged Mutual Funds

As part of the Israel Securities Authority’s (ISA) move to make investing in hedge funds more accessible to the public and to develop mechanisms for their oversight, the ISA published a document for public comment.

It details the core characteristics of two new financial products – an alternative mutual fund of the hedge fund type and hedged mutual fund of funds.

The general idea behind hedged mutual funds is a hybrid of mutual funds and hedge funds, while adjusting the existing regulation governing mutual funds to the characteristics of hedge funds.

The Primary Regulatory Adjustments

Permanent Fund: In most mutual funds, it is possible to make a sale or purchase of their units on any day in which trade occurs on the Tel Aviv Stock Exchange. The ISA proposes that for hedged mutual funds it be possible to purchase or redeem units at set dates, when the period between such dates is no less than three months and no more than six months.

Publishing Unit Rates: Mutual funds publish their unit rates on any day in which trade occurs on the TASE. It is proposed that a hedged mutual fund publish its unit rates near to and on the date when the purchase or sale becomes possible.

Maximum Exposure Rates for Shares and Foreign Currency: The maximum exposure rates of mutual funds are set according to each fund’s investment polity. It is proposed that hedged mutual funds’ exposure rates for shares or for foreign currency not exceed 320% and not fall below negative 220% of the net worth of the fund’s assets, with a fund manager authorized to set lower maximum rates.

Investment Rules: It is proposed that hedged mutual funds not be subject to various investment restrictions that apply to investments by mutual funds, such as maximum exposure rates for securities issued by a corporation or state, a maximum rate for options, and a maximum rate for non-tradable assets.

Success Fees: It is proposed that in light of the unique characteristics of hedged mutual funds, a fund manager be authorized to collect a performance success fee (which is not permitted for mutual funds).

Managing the Fund’s Investment Portfolio: Only those licensed to manage portfolios are permitted to manage the investments of mutual funds. It is proposed that for a hedged mutual fund the license requirement be waived as long as the fund manager has at least one year’s proven experience in managing investment portfolios with similar characteristics to those of a hedged mutual fund.

Hedged Mutual Fund of Funds: Similarly to the financial product of a mutual fund of funds, whose purpose is to enable investment in several mutual funds through investment in a single product, so should it be possible to invest in several hedged mutual funds through a single number – i.e. a hedged mutual fund of funds.

This move is a direct continuation and result of the legal ruling that considered the collapse of the hedge fund “Integral”. In that decision, the court noted that in light of the increase in the number of hedge funds in Israel, as well as the need to protect the investing public, specific regulations should be established to govern hedge fund activity.

These regulations should consider hedge funds’ unique characteristics, such as the composition of their assets, the ways in which they invest, their reporting and registration duties, and clear rules of conduct. The ISA document is still subject to public comments and the completion of necessary legislative processes, but it seems the ISA has picked up the mantle and is working toward improving the capital market and expanding the range of investment products for the benefit of the general public.