Special Funds in Kenya: Investing Beyond the Traditional

Introduction

A special fund a type of Collective Investment Scheme (CIS), governed under The Capital Markets (Collective Investment Schemes) Regulations, 2013. Like other CIS, they pool money from investors, and this money is managed by a professional fund manager.

Special Funds have more operational flexibility compared to standard Unit Trusts (like Money Market Funds). They can invest in a wider variety of assets, invest in international markets, and sometimes use leverage (borrowing) to enhance potential gains. As one might imagine, this approach targets higher returns, but also involves higher risks.

This guide will delve into the structure, objectives, benefits, risks, and essential considerations for navigating Special Funds in the Kenyan market.

Structure and Governance of Special Funds

Special Funds in Kenya operate under a regulated structure designed to ensure professional management, oversight, and protection of investor assets. This framework, overseen by the Capital Markets Authority (CMA), mandates specific roles and responsibilities, all detailed within each fund’s foundational legal document, typically the Information Memorandum (IM) or Prospectus.

The key players are:

1. The Fund Manager:

   The engine of the fund, a Fund Manager:

   • develops the investment strategy,
   • selects assets according to the fund’s objectives (as outlined in the IM),
   • manages the portfolio daily, and handles administration.

   Examples of licensed Fund Managers offering Special Funds in Kenya include Standard Investment Bank (SIB), Faida Investment Bank (FIB), CIC Asset Management, Dry Associates, etc.

2. The Trustee:

   The investor’s watchdog, a Trustee is an independent entity, often a bank or specialized trust company responsible for overseeing the Fund Manager’s activities. They ensure the fund operates according to the IM and regulatory requirements, acting primarily to safeguard the interests of the investors.

3. The Custodian:

   The safekeeper of assets - typically a CMA-approved bank, a Custodian holds the fund’s assets separate from the Fund Manager’s own assets, providing a critical layer of security against misuse or loss.
   
   This role is usually fulfilled by reputable commercial banks operating with specific custodial service licenses.

This “triangle” structure – Manager, Trustee, Custodian – alongside the detailed rules set out in the Information Memorandum and oversight by the CMA, provides the governance framework intended to ensure transparency, accountability, and investor protection within Special Funds in Kenya. Investors must carefully read the Information Memorandum before investing, as it contains vital details about the specific fund’s structure, strategy, fees, and risks.

Objectives and Investment Focus

Unlike traditional funds often benchmarked against specific market indices, Special Funds typically pursue more distinct objectives, often aiming for absolute returns, significant inflation hedging, or capital growth by tapping into less conventional opportunities.

Their core strategy revolves around investing in areas typically inaccessible or restricted for standard Unit Trusts. However, the investment focus of specific funds is diverse and dictated by their mandate - outlined in each  fund’s Information Memorandum (IM).

Common investment areas include:

• Global markets: A key attraction is access to international investments. This can include:
  • Global equities: Investing in stocks listed on major international exchanges (e.g., NYSE, LSE).
  • Global bonds: Accessing government or corporate debt from various countries.
  • Index funds & ETFs: Gaining broad exposure to global or thematic indices.
• Alternative Assets: This is where Special Funds significantly differ from traditional funds, often allocating heavily (potentially up to 80% of assets) to:
  • Real estate: Beyond REITs, this might involve direct investment in property development projects (commercial, residential), rental properties, or specialized real estate opportunities within Kenya or regionally.
  • Private equity: Investing directly in unlisted private companies in Kenya or Africa, seeking high growth potential before they go public or are sold.
  • Commodities: Gaining exposure to physical assets like gold, precious metals, oil, or potentially structured products linked to agricultural commodities.
  • Infrastructure: Participating in large-scale projects like energy, transport, or social infrastructure, often via specialized vehicles.
  • Derivatives and structured products: Some Special Funds may utilize financial contracts like:
    • Foreign exchange (FX) contracts: For hedging currency risk from global investments or for speculative trading strategies (e.g., Contracts for Difference - CFDs).
    • Other derivatives: Options, futures, or swaps linked to interest rates, equities, or commodities, used for hedging or amplifying returns (this significantly increases complexity and risk).
    • Fixed income (beyond vanilla): May include higher-yielding corporate bonds, private debt, or distressed debt opportunities, locally or internationally.

Many Special Funds in Kenya are positioned as “Multi-Asset” Funds, meaning they strategically blend several of the above categories (and potentially some traditional assets) to achieve diversification and specific risk-return profiles.

Fund managers employ intensive research and active management, sometimes utilizing leverage (borrowing) as permitted in the IM, to achieve the fund’s specific high-yield or growth objectives. The availability of both KES and USD denominated funds, as well as Shariah-compliant options, further caters to diverse investor needs and preferences.

Benefits of Investing in Special Funds

While carrying higher risks (discussed later), Special Funds offer several advantages that attract investors seeking opportunities beyond conventional investments. Key benefits include:

1. Access to unique and global opportunities

   Special Funds provide a gateway to asset classes and markets often out of reach for individual investors. This includes direct participation in international stock and bond markets, and global commodities, private Kenyan companies (private equity), and large-scale real estate development projects.

2. Enhanced portfolio diversification

   By investing in assets with potentially low correlation to traditional Kenyan markets (like NSE equities or local bonds), Special Funds can significantly improve overall portfolio diversification. Exposure to global economies,  different asset types (e.g., private equity, commodities), and non-typical strategies.

3. Potential for enhanced returns

   The flexibility to invest in high-growth areas (like private equity), access global opportunities, utilize specialized strategies (like derivatives for hedging or return enhancement), and potentially employ leverage gives Special Funds the potential to generate returns exceeding those of traditional funds or bank deposits. The funds are often able to outperform alternative investment options like Money Market Funds which are limited to domestic markets. This is a major draw for investors.

   However, these higher potential returns are directly linked to higher risks and are not guaranteed.

4. Professional management and expertise

   Navigating complex alternative assets and global markets requires specialized knowledge. Special Funds are managed by licensed professionals with expertise in researching, selecting, and managing these sophisticated investments.

5. Structured and regulated environment:

   While flexible, Special Funds operate within the CMA’s regulatory framework. The required structure (Fund Manager, Trustee, Custodian) and the rules outlined in the Information Memorandum provide a formal governance system, regular reporting requirements, and oversight mechanisms designed to protect investor interests, offering a more structured approach than direct, unregulated investments in similar assets.

These potential benefits make Special Funds a compelling option for suitable investors looking to add sophisticated exposures and growth engines to their portfolios. However, these advantages must be weighed carefully against the inherent risks involved.

Risks and Mitigation Strategies

The pursuit of higher returns through flexible and often complex investment strategies means Special Funds inherently carry higher and more varied risks compared to traditional Unit Trusts like Money Market or Bond Funds.

Potential investors must understand and be comfortable with these risks before committing capital. Key risks include:

1. Market risk: Investments, whether local or global, are subject to market fluctuations driven by economic conditions, geopolitical events, interest rate changes, and investor sentiment that add layers of market volatility.

2. Liquidity risk: This is a significant concern. Many underlying assets (e.g., real estate projects, private equity stakes) are inherently illiquid, meaning they cannot be easily or quickly sold without a substantial loss in value.

   Accessing your money quickly may not be possible, due to:

   • Lock-in periods: Many Special Funds require investors to commit capital for a minimum period (e.g., 6 months, 1 year, or longer).
   • Redemption restrictions: Withdrawals might be limited to specific intervals (e.g., quarterly) or require lengthy notice periods, even after the lock-in period.

3. Valuation risk: Accurately pricing illiquid assets like private company shares or unique properties can be challenging and subjective. Valuations might be infrequent, potentially leading to discrepancies between the reported Net Asset Value (NAV) and the true realizable value.

4. Leverage risk: The use of borrowed funds (leverage) can magnify both gains and losses. While it can boost returns in favourable markets, it can significantly deepen losses during downturns, potentially even leading to a total loss of invested capital in extreme scenarios. Investors should check the Information Memorandum (IM) for leverage limits and monitor reported leverage levels.

5. Currency (Foreign Exchange) risk: For funds investing globally, fluctuations in exchange rates between the KES and foreign currencies can significantly impact returns when translated back into KES. Even for USD-denominated funds, the underlying assets might be in other currencies, creating exposure.

6. Concentration risk: Unlike broadly diversified traditional funds, Special Funds may concentrate investments in specific sectors, geographies, or even a small number of deals. While this can drive high returns if successful, poor performance in a concentrated area can heavily impact the entire fund.

7. Manager & strategy execution risk: The fund’s success is heavily reliant on the skill, experience, and integrity of the Fund Manager and their team. Poor investment decisions, inadequate risk management, or failure to execute the stated strategy effectively are significant risks.

8. Style drift risk: There’s a risk that the fund manager might deviate from the investment style or objectives stated in the IM, perhaps chasing short-term performance. This could lead to unintended risk exposures or misalignment with the investor’s original expectations.

9. Credit & counterparty risk: If the fund invests in debt instruments (bonds, private loans), there’s a risk the issuer defaults. For derivatives or other contracts, there’s counterparty risk – the risk that the other party to the transaction fails to meet their obligations.

10. Fee impact: Special Funds often have higher fee structures, potentially including significant management fees (e.g., up to 5-6% annually mentioned in some reports) and performance fees (a percentage of profits above a certain threshold). These fees directly reduce investor returns.

11. Regulatory risk: Changes in regulations by the CMA or other relevant bodies, or shifts in tax laws, could affect the fund’s operations or the tax treatment of returns.

Mitigation Strategies (by the Fund Manager):

Fund Managers employ various strategies to mitigate these risks, although they cannot be eliminated:

• Thorough due diligence: Conducting in-depth research and analysis before making any investment.
• Diversification (within Mandate): Spreading investments across different assets, sectors, or geographies within the limits of the fund’s specific strategy.
• Active risk management: Continuously monitoring market conditions, portfolio exposures, and leverage levels.
• Hedging: Using financial instruments (like FX forwards) to offset specific risks, particularly currency risk, where appropriate and disclosed in the IM.
• Adherence to mandate: Sticking to the investment strategy and risk parameters defined in the Information Memorandum.
• Clear disclosures: Providing transparent information about risks, holdings (as seen in some fact sheets), and strategies in the IM and investor reports.

Investor’s role: Investors mitigate their risk by understanding these factors, reading the IM thoroughly, assessing their own risk tolerance and investment horizon, diversifying their overall wealth across different investment types (not just placing everything in one Special Fund), and monitoring fund communications.

Key Considerations for Investors

Investing in Special Funds requires careful thought and alignment with your personal financial situation and goals. Before committing capital, consider the following critical factors:

1. Eligibility and Suitability:

   • Risk Tolerance: Honestly assess your comfort level with potential volatility and the possibility of losses. Special Funds generally fall into the moderate-to-high risk category due to their underlying assets and strategies (like leverage). They are typically not suitable for risk-averse investors or those needing guaranteed capital preservation.
   • Investment Horizon: Given the focus on illiquid assets and long-term strategies (like private equity), Special Funds are best suited for investors with a medium-to-long-term investment horizon (typically 3-5 years or more). They are generally inappropriate for short-term savings goals.
   • Financial Capacity: Can you afford the higher minimum investment and potentially tie up this capital for the required duration without impacting your essential financial needs?
   • Sophistication: While not always legally restricted, the complexity often makes these funds more appropriate for investors with some financial knowledge or access to professional advice (‘sophisticated investors’).

2. Minimum Investment Amounts and Lock-in Periods:

   Be prepared for significantly higher minimum investment requirements compared to standard Unit Trusts. Initial investments can range from KES 250,000 to KES 500,000 or more (or the USD equivalent, e.g., USD 2,500). Minimum top-up amounts also apply (e.g., KES 50,000 - KES 100,000).

   Expect mandatory lock-in periods, often starting from 6 months or longer, during which you cannot withdraw your funds. Understand the specific lock-in and redemption terms outlined in the IM.

3. Understanding the Fee Structure:

   Fees directly impact your net returns and can be substantially higher than traditional funds. Scrutinize the fee structure detailed in the IM, which typically includes:

   • Annual Management Fee: A percentage of the assets under management (AUM), potentially ranging from 2% to as high as 6% per annum, charged proportionally over the year.
   • Performance Fee (Incentive Fee): Often charged on returns exceeding a predefined benchmark or “hurdle rate”. For example, a fund might charge 10% on all returns above a 25% annual hurdle rate, as seen in some Kenyan funds.
   • Other Fees: Check for potential entry fees, exit fees (especially for early withdrawal if permitted), trustee fees, or custodian fees that might be passed on. High combined fees (MER - Management Expense Ratio) create a significant drag on performance.

4. Thorough Due Diligence - Read the Documents:

   The Information Memorandum (IM) or Prospectus is essential reading. Do not invest without carefully reviewing this legal document. Pay close attention to:

   • Investment Objectives and Strategy: Does it align with your goals?
   • Asset Allocation: What exactly will the fund invest in? What are the limits?
   • Risk Factors: Understand all disclosed risks.
   • Fees and Charges: All costs involved.
   • Lock-in Periods and Redemption Terms: How and when can you get your money back?
   • Fund Manager Profile: Their experience and track record.
   • Valuation Policy: How are illiquid assets valued?
   • Leverage Policy: Is leverage used, and what are the limits? Also review Fund Fact Sheets (often issued monthly or quarterly) for recent performance, holdings (if disclosed), and manager commentary. Examples like Mansa-X and Oak Fund show increasing transparency in fact sheets.

5. Tax Implications:

   Understand how returns from the Special Fund will be taxed in Kenya. This typically involves withholding tax on income distributions. Capital gains tax might also apply depending on the fund structure and underlying transactions. Tax rules can be complex and may change; it is highly advisable to consult with a qualified tax advisor to understand the specific implications for your situation.

6. Investment Process:

   Investing usually involves contacting the Fund Manager directly, completing application forms, providing Know-Your-Customer (KYC) documentation, and transferring the investment amount according to their instructions.

7. Consider Professional Advice:

   Given the complexity and risks, if you are unsure whether a Special Fund is right for you, seek advice from a licensed and independent financial advisor who understands your complete financial picture and can assess the suitability of such an investment within your overall portfolio.

Making an informed decision requires looking beyond advertised potential returns and carefully weighing these practical considerations against your individual circumstances.

Popular Special Funds in Kenya

Mansa X Special Fund

The fund is one of the largest in Kenya, with its assets under management (AUM) reaching Ksh. 34.23bn ($264m) in September 2024. It quickly surpassed large traditional funds that focus exclusively on domestic financial markets.

Oak Special Fund

Faida Investment Bank Limited received approval to establish the Oak Multi-Asset Special USD Fund under in November 2024. It is a USD-denominated fund targeting high-yield assets such as global sovereign bonds, corporate bonds, and derivatives, offering medium to high-risk investment options and a T+2 settlement period after a six-month lock-in.

Etica Special Wealth Fund

CIC Global Special Fund

Old Mutual Special Fixed Income Fund

Madison Wealth Special Fund

DAL High Yield Special Fund

Dry Associates Limited (DAL) converted its Balanced Fund into the DAL High Yield Special Fund in late 2024. It focuses on high-yield returns through Kenyan and East African government securities and corporate fixed-income investments. Targeting moderate to aggressive investors, the fund provides structured asset allocation across short- and long-term fixed-income securities.

Conclusion

Special Funds represent a dynamic and evolving segment within Kenya’s Collective Investment Schemes landscape. They offer a distinct proposition compared to traditional Unit Trusts, primarily characterized by their operational flexibility. This allows professional fund managers to pursue potentially higher returns by accessing a broader universe of investments, including non-traditional assets like private equity and real estate, global market securities, and potentially employing leverage. For investors, this translates into opportunities for enhanced diversification away from local markets and access to unique growth avenues previously difficult to reach individually.

However, this potential comes with significantly higher and more complex risks. Investors must carefully consider the implications of illiquidity (including lock-in periods), the potential magnification of losses throughleverage, the impact of higher fees, currency fluctuations, and the critical reliance on the fund manager’s expertise. Special Funds are therefore generally suited for investors with a higher risk tolerance, a longer-term investment horizon, and the capacity to meet potentially substantial minimum investment requirements.

Ultimately, deciding whether to invest in a Special Fund requires thorough due diligence. Carefully reading the * Information Memorandum*, understanding the specific strategy, scrutinizing the fee structure, assessing the risks involved, and potentially seeking guidance from a licensed financial advisor are crucial steps. While Special Funds offer a compelling pathway for sophisticated investors seeking to enhance their portfolios, an informed and cautious approach is essential to navigating this sophisticated investment vehicle successfully within the Kenyan market.