Global search for yield – SA hedge funds a viable option

September 15, 2016
Victoria Gorman

Over the years, international investors have searched for yield and found themselves looking towards Africa. Onesource of remarkably consistent alpha and attractive risk- adjusted returns has been the South African hedgefund industry. With a market capitalisation of US$354bn, the Johannesburg Stock Exchange (JSE) has an averagedaily trading volume of US$1bn.The cost to borrow in many emerging markets outperforming their global peers.Since January 2007, the HedgeNews Africa South African Single Manager Composite Index annualised10.7%1. Over the same period, the Hedge Funds Reserach Inc. (HFRI) Fund Weighted Composite Indexannualised 3.1%2. Over a three-year and five-year timeframe, the comparable statistics looksimilar.While the South African peer group is made up of rand denominated funds, a smaller sub-set of South African hedgefundIn Novare’s 2015 Hedge Fund Survey, it was reported that the South African hedge fund industry totalled R62.0billion (US$4.8bn3) in assets under management. The South African traditional long-only unit trust market is estimated to be around R2 trillion (US$155bn). There is no question that being a good stock picker is what makes money but to generate alpha and outperform, longer term investors need to have the ability to be nimble.

Not just a South African play

One of the interesting points about the South African equity market is that it is quite diversified with ameaningful portion of the index being internationally exposed. RMB Morgan Stanley recently put out a researchreport outlining the JSE’s geographical composition. Over the past 10 years the offshore exposure of the JSE Top40 Index, which is an index comprised of the top 40 stocks by market- capitalisation listed on the exchange, hasgrown by 30% and now stands at 73%.The diversification of the JSE is perfect for hedge fund investing. Not only can managers 'golong' on stocks which derive meaningful earnings from offshore but they are able to short companies whichare geared to the South African economy. Having this optionality allows hedge fund managers to be nimble andthey are able to capitalise on opportunities can be quite expensive and in most cases borrowing is non-existent.This is not the case in South Africa. The cost to borrow on the JSE is approximately 50 basis points per annumand the exchange has a very liquid options market. The country’s financial infrastructure and regulatoryframework ranks amongst the top globally when it comes to best practice. In fact, South Africa’s financialmarket development overall ranks just outside the top 10 according to the 2015-16 World Economic Forum report.South African hedge fund managers have done an exceptional job in managers have attracted international capitalover the years by offering dollar denominated investment vehicles. These funds have still managed to generatedouble digit net annualised returns in their dollar funds, something most hedge funds managers abroad struggleto achieve over an extended period of time.So how have South African hedge funds managed to outperform?

Size does matter

The global hedge fund industry reached US$3.2 trillion at the end of 2015 with a majority of assets being managedin the US and Europe

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