31 July 2014

Flexible, unconstrained and focused on performance


Increasing assets from R33bn to R42bn in 2013 represents impressive growth for the local hedge fund industry in 2013. Boosted by the changes to Regulation 28 (that increased maximum hedge fund exposure to 10%), increased awareness of hedge fund manager regulation, and the imminent hedge fund regulations in CISCA (Collective Investment Schemes Control Act) hedge funds have received more positive attention than in previous years. Hedge funds, and their managers, offer investors opportunities for real returns and flexible fund management.

Gavin Vorwerg, co-founder and portfolio manager at Laurium Capital, believes that hedge funds offer managers an unconstrained way to manage money, have a high degree of flexibility and don’t impose limitations that long-only funds may have, like tracking indices. Hedge funds allow managers and investors to “make money in broader parameters.”

Long only fund management allows for an investment in a particular share, for example. And typically this would be done if the fund manager thought the share could make money and offer potential good returns. To buy a share a long only manager would need to like its prospects. Manage a hedge fund – and you can make money from both a positive and negative view.

Hedge fund managers have the ability to short capital – Vorwerg says this is fundamental to any hedge fund – and a logical extension of analysis and research. Unlike a long only manager – a hedge fund manager can buy a share for returns if they like it - and short sell if they don’t.

The flexibility of hedge funds doesn’t only come from strategies used – it is also inherent in the smaller size of hedge funds. Smaller funds can be more nimble, react faster to information, and take more meaningful positions in mid and small cap stocks. An ideal size for a hedge fund is most often given as R500m – R2bn. In the hedge fund space in South Africa, Vorwerg says R3-4bn is considered big, whereas in the long-only space, that would be a very small manager.

Performance is key to a hedge fund manager. “Hedge funds are super-focused on performance and generally less focused on asset gathering,” Vorwerg comments.

Appreciating this is one of the keys to understanding most of the South African hedge fund market. The managers are highly skilled and experienced, invest in their own funds, and well regulated.

To label all hedge funds (and hedge fund managers) as high risk may be misleading. The risk profile of a particular hedge fund depends on the mandate of that fund – some mandates may be very aggressive, while others may be designed to focus on hedging and delivering low volatility returns. Compared to the risk return profile of the multi asset CIS category, Long Short funds, which are the most common funds in South Africa, offer better returns at lower volatility (see graph below). There are hedge fund mandates to accommodate a range of risk appetites, Vorwerg observes. Key factors that must be assessed when considering a hedge fund are net exposure, gross exposure, position sizing, sector concentrations, and liquidity risk.

Hedge funds are not suitable investments for every investor. You do need to have a decent amount of funds available to invest, and if you are in a Reg 28 structure your exposure will be limited. In addition – the fees are higher than most other CIS funds. Vorwerg says that if you generate alpha then investors are generally happy to reward you for it.

Vorwerg sees long-short equity hedge funds as a protected equity strategy. What these hedge funds generally offer is less beta exposure, and their investment objectives are real returns. In a world where real returns should be the ultimate investor goal this is their unsung advantage.


Risk Return: Long Short Index vs. Asset Allocation Funds (3yrs to end April 2014)


Graph risk return

Source: Symmetry Survey April 2014 and Profile Data