Focus on Risk Adjusted Returns

March 14, 2016
Victoria Gorman

Blue Chip chatted to Murray Winckler, co-founder and portfolio manager of Laurium Capital, about how best to understand the imminent retail investor hedge funds (RIHFs) to be launched in South Africa under CISCA (Collective Investments Schemes Control Act).

Globally, the hedge fund industry is very well established, with over two trillion US dollars of assets under management and a number of sophisticated strategies for investors to choose from.By contrast, South Africa has been a very small industry. Winckler explains: “In total we have about R60 billion of assets, so it’s not even 5 billion dollars. Compare that to the long-only industry in South Africa, where you have close to R2 trillion in unit trusts.”This can be attributed primarily to regulatory differences. Internationally, Winckler points out, comparatively light regulations have allowed hedge funds to develop extremely flexible financial instruments, attracting investors including pension funds and endowments. More conservative South African regulations have meant that hedge funds have been private investments suitable only for sophisticated investors, and not open to the general public.This year, things are set to change with the advent of hedge funds being formally registered collective investment schemes with the Financial Services Board.“The man in the street in South Africa will be able to invest in hedge funds,” says Winckler. “Whereas previously to invest in a hedge fund you needed to be a qualified investor and typically invest a minimum of a million rand. The new regulations make RIHFs more accessible through a minimum investment amount of R50 000. Consequently we expect more demand from the retail space and pension funds, and for the industry to grow going forward.”Given the option to add hedge funds to your portfolio, investors should be aware of the particular risk and return benefits to assess when analysing them. “Hedge funds are less constrained than long only investment products and incorporate additional investment strategies such as gearing, scrip borrowing and short selling. These strategies can reduce portfolio risk, preserve capital and produce returns with less correlation to that of traditional asset classes.”Naturally, it is essential for individuals and financial advisors alike to understand the risks around hedge funds. In general, says Winckler, “South African hedge funds have proven much less risky than their international counterparts.”The combination of flexibility and reasonable risk bodes well for growth. “I think it is not inconceivable in the next three years that the hedge fund space in South Africa will double from the present level of some R60 billion.“Laurium runs three hedge funds in South Africa: a low-risk Market-Neutral Fund, our flagship Long/Short Fund, which has got medium risk, and then an Aggressive Long/Short Fund, which takes more risk. Our flagship Laurium Long Short Fund has delivered 14.7% per annum after fees (10% real return) since inception, at half the volatility of the JSE All Share Index (return of 12.5% per annum).

Protection on the downside

One way to gauge a hedge fund's performance is maximum drawdown (the peak-to-trough decline during a specific record period of an investment). According to Winckler, Laurium's Long Short Fund has had a maximum drawdown of 10.8% over eight years, compared with a maximum drawdown of 37% for the All-Share Index over the same period. Effectively, he says, “Hedge funds can protect people from themselves. When markets get really bad and sentiments get bleak, many investors exit the market at invariably the wrong time: they don’t get back in, the market zooms back up, and they are out in the cold. - “So protection on the down side is one of the big benefits of a hedge fund.”

Understanding the market

To grasp how companies such as Laurium Capital operate, it is necessary to look at two key numbers: net exposure and gross gearing.“Since inception,” Winckler explains, “the Laurium Long Short Fund has had an average net exposure of 52%. Net exposure (long positions less your short positions) is an important indicator of potential downside risk“The other key factor is the level of gross gearing (long positions plus short positions).The Laurium Long Short fund has had an average of 150% gross exposure, which is relatively conservative. Other funds may run much higher gross and net exposures, so hedge funds can sit almost anywhere on the risk return spectrum.Market Neutral funds on the other hand, usually involve taking long and short positions of the same size so that the portfolio is cash or beta neutral, or both. Typically these funds have a small net exposure to the market and leverage is used to enhance returns. The Laurium Market Neutral Fund has had an average gross exposure of 121% and an average net exposure of 5.9%. Correlation to the market is 0.03% and it has delivered a return of 12.2% per annum (net of fees) since inception 1 Jan 2009 to end December 2015, with a maximum drawdown of 1.3%.

Anyone can play

Up until now, many qualified investors have invested in hedge funds directly or through independent risk managers “Now,” Winckler says, with the changes in regulations, two of Laurium Capital's funds should be registered as RIHFs and available to retail investors once approved by the FSB.“So, exactly the same as any normal unit trust, individuals will be able to invest in the Laurium Capital Long Short Fund or the Laurium Capital Market-Neutral fund.”

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