New Investment Products: Hedged Mutual Funds and Hedged Mutual Funds of Funds

Barnea Jaffa Lande & Co.
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With the goal of expanding the public’s investment options, the Israel Securities Authority published in February 2020 a first draft of a document for public comments. The document details the core characteristics of two new financial products: a hedged mutual fund and a hedged mutual fund of funds.

The idea behind these products is to combine the characteristics of a supervised “mutual fund” and those of a currently unsupervised “hedge fund.” This will enable the investing public to enjoy the best of both worlds: access to the world of unsupervised hedge fund investments and regulation of these products as trust funds for all intents and purposes, including, inter alia, supervision by the ISA.

Recently, the ISA published a second draft of the document detailing the core characteristics of these products. Its intent is to continue promoting these products, examine their unique characteristics, including how they are cleared, and later work toward amending the current legislation (also to be brought for public comments).

The primary updates on alternative mutual funds of the hedge fund type are as follows:

  1. The schedules for advance notice to order units of the fund and redeem them has been changed from 14 days to 10 days. We note that the hedged mutual funds will be fixed-date funds, insofar as it is possible to order to redeem their units at times defined by the funds managers, and the proximity in time between these actions shall be at least three months and shall not exceed six months.
  1. Fund managers are required to publish the purchase prices and redemption prices of their funds’ units three trade days in advance of the last notice deadline.
  1. The restriction on the maximal exposure rates of the funds to shares or foreign currency has been removed.
  1. The updated draft still allows collection of success fees for hedged mutual funds, but the conditions for collecting them have been changed. The previous draft allowed the fund manager wide discretion with calculation methods. In the updated draft, the discretion and range of permissible operations by the fund manager is significantly restricted.
  1. The mandatory qualification standard required for a participant in the decision-making on the investment management of the fund’s portfolio, who is unlicensed but has proven experienced in managing a portfolio with similar characteristics to those of a hedge fund, has been raised from one to three years.
  1. In addition, the updated draft includes some entirely new provisions, including:
  1. The fund manager’s duty for full disclosure to the Israel Securities Authority and the Tel Aviv Stock Exchange on the assets held by the fund. Such reports shall be submitted once a month and shall not be open for public review.
  2. A restriction on the fund manager managing more than one hedged mutual fund, with the exception of funds managed through outsourcing (hosting).

The primary updates on hedged mutual funds of funds are as follows:

  1. The schedules for advance notice in terms of ordering and redeeming units have been amended to be identical to those made regarding hedged mutual funds. The notices are due 10 days prior to the deadline.
  1. The calculation and publication of the unit price and redemption of the fund of funds shall be published on the 20th day of each month for the day of price calculation of the month prior.
  1. The types of assets the hedged mutual fund of funds may purchase was expanded.
  1. Despite the expansion of the types of assets that may be purchased, a new provision was added stipulating that the total value of the hedge fund units held by the fund of funds shall be at least 75% of the net value of the fund of funds.
  1. Similarly to hedged mutual funds, here too, managers of funds are limited to management of only one fund of the hedged mutual fund of funds type. The appointment of an external, unlicensed individual to make decisions on managing the fund is also possible, so long as such person has a minimum of three years’ experience. (The previous draft did not permit the appointment of such an external individual.)
  1. A new requirement stipulates an administrator must be appointed to ensure the rights of investors in the hedge fund through oversight of every deposit or withdrawal of funds from the hedge fund’s account, including the need to pay management and success fees to the fund manager.
  1. The fund of funds’ manager’s salary shall not be paid out of the deposits held by the fund of funds.
  1. The reference to holding “affiliate” hedge funds was expanded to require the fund manager to make known already in the investment policy if he intends to hold “affiliate” funds. In such case, the fund of funds’ assets may not be used to pay the fund manager’s salary for the affiliate funds held by the fund of funds.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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