Hedge funds are not accorded their rightful place in the South African investment world, despite their ability to out-perform even the best performing equity funds. Globally, hedge funds account for $4 trillion of assets, compared to about R80 billion locally.
However, they are underrepresented when it comes to portfolios, despite their ability to protect assets during turbulent times, such as now. Unit trusts, by comparison, provide at least 1,700 fund options with a collective assets of more than R3 trillion (Source: ASISA CIS Stats, 30 September 2022).
The point of hedge funds is to provide investors with positive returns, while reducing risk, even when it comes to more aggressive solutions. What makes these funds unique is the fact that they use derivatives, short selling, and leverage. This means that managers can extract positive performance in bull markets, while protecting investors’ capital during bear financial markets.
While hedge funds invest in the same asset classes as the more typical vehicle of unit trusts, they benefit from being able to take advantage of a range of price adjustments using the additional tools available to them, which means they produce other sources of differentiated returns.
These funds are often run by boutique companies, with fewer assets than the larger managers, and flat organisational structures, allowing them to be agile when it comes to making and executing decisions quickly. This makes them ideal for both personal and institutional investors, with retail investor hedge funds available directly and on many LISPs with low minimum investment requirements, while qualified investor hedge funds require a minimum investment of R1 million.
Many of these boutique managers have stemmed from some of the large, international institutions in South Africa and have excellent long term track records of 15 to 20 years, growing clients’ wealth and protecting assets.
In fact, a good measure locally when it comes to decision-making is that a quarter of a portfolio should be in hedge funds, while this figure comes in at about half of the allocation in some of the top US endowments’ allocation to hedge funds. That can be put down to the perception that hedge funds are not better than other forms of putting away money for retirement or other needs. This perception, however, is far from the truth.
Highly skilled individuals are hands on when it comes to protecting investments, and ensuring that they outperform inflation, which currently seems to be running rampant in South Africa. There are also options for all investors, from funds that are more conservative, to others that have higher risk.
The Laurium Aggressive Long Short Prescient QI Hedge Fund (“Laurium Aggressive LS”), which celebrated its tenth birthday on 1 January this year, delivered returns of 23.2% last year net of fees, and an annualised performance of 16.1% per year for 10 years, which is double the return of the equity market over the same time with the FTSE/JSE Capped SWIX returning 8.3%. And this with only 9% more risk (volatility) relative to the equity market.
However, risk management is vital to ensure that, when returns dip – as they do in any portfolio – they are smoothed out through careful management. One way of ensuring that your money is well looked after is to trust a company with a track record. We’ve been around for almost 15 years, for example.
Another aspect that may put people off hedge funds could be the fact that they weren’t really regulated as such until about 2016. Under the Collective Investment Schemes Control Act (CISCA) regulations, they are seen as unit trusts with the same consumer protection, although many people may not know there are very specific risk and reporting requirements under the ambit of CISCA, which – in theory – should make them more accessible to investors.
There is also a lack of general understanding of what hedge funds do, which is to protect money during the bad times. People are always worried about fees, as hedge fund fees may be higher than traditional funds, especially when they are performing well, but returns are reported and should be looked at on a net of fee basis.
Most advisors and institutional investors will offer their clients a diversified portfolio, which should allow them to smooth out the bumps that happen in markets as a matter of course. Hedge funds provide good downside protection that one needs to ride out the waves.
Hedge funds don’t replace traditional equity funds, but rather augment them. Allocating a portion of your investment to hedge funds can improve overall returns and should be viewed as one of the building blocks of a well-diversified investment portfolio.
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