Hedge funds can be a great diversifier

In volatile times, when investors are not achieving returns out of traditional asset classes, hedge funds can be a great diversifier. While there has been a wide dispersion of returns in individual hedge funds, many performed extremely well in 2019. The new ASISA Hedge Fund Classification Standard comes into effect on 1 January 2020, with the aim of classifying all hedge fund portfolios, including hedge fund offund portfolios, into different categories. The aim is to make it easier for investors to assess and compare funds and to select hedge funds appropriate for their risk profiles and investment portfolios.

What makes hedge funds different from traditional investing?

       
• Long-only fund managers analyse stocks, make decisions to buy, sell or hold
       
• Hedge fund managers need to be able to do this well – and more. Hedge fund managers have a lot more tools in their toolbox. Hedge funds can use leverage, and other strategies such as shorting, which allows them to generate returns from both a positive and a negative view
       
• Managing hedge funds can be more complex than long-only funds, and so requires a different skillset
       
• Most hedge fund managers in SA have skin in the game and are prepared to invest a large proportion of their investable assets in their own funds.

What are the benefits of investing in hedge funds?

       
• Equity-like returns (after fees) with lower risk
       
• Protection of capital
       
• More investment options via a larger ‘toolbox’
       
• Diversification: better risk-adjusted returns Highly regulated environment
       
• SA has quality managers with long, consistent track records
       
• Complement rather than replace long-only funds.

Are hedge funds a high-risk investment

To label all hedge funds (and hedge fund managers) as high risk is misleading. The risk profile of a particular hedge fund depends on the mandate of that fund. Some mandates may be very aggressive, using leveraged positions, while others may be designed to focus on hedging and delivering low volatility returns. There are hedge fund mandates to accommodate a range of risk appetites.

What are the risks

Hedge funds are obviously not without risk, as history internationally has shown. Fortunately, hedge fund managers in SA have proven themselves to be more conservative than their international counterparts – there are some experienced managers that have long, consistent track records to prove it.

Furthermore, hedge funds are now much more transparent and highly regulated by the FSCA

       
• Short positions increase more than long positions
       
• Leverage can amplify the loss (and gains)
       
• Liquidity in short positions is key
       
• Choose a manager that has a solid track record and robust investment risk management.

How much do you think should be allocated to non-traditional assets

At least 15-20% of an investor’s portfolio should be invested in assets that are non-correlated to traditional investments, which makes hedgefunds a key part of any well-diversified portfolio.

With the restrictive nature of Regulation 28, is there enough allocation within a retirement fund to effectively use a hedge fund to benefit the membership

Regulation 28 allows for a 10% total allocation to hedge funds (2.5% per fund). However, CISCA, the legislation that governs CIS funds (unit trusts) does not currently allow investments in hedge funds, even though they are now regulated by the FSCA under CISCA. We believe this should be amended as soon as possible to align with Regulation 28.

Why do you think hedge fund assets in SA remain small (estimated R40bn) relative to CIS industry assets of over R2tn?

There is a misconception that hedge funds are risky investments, when in fact SA hedge fund managers are relatively conservative, constraining downside performance and reducing volatility. We suspect this may also be due to the funds not being available to retail investors via LISPs, which are the primary channels used by financial advisers, and due to the fact that advisers and investors alike do not have a good enough understanding of their benefits to be able to invest with confidence. We believe that the introduction of daily priced, daily traded investment options on RIF hedge funds like the Laurium Long Short Fund and Laurium Market Neutral Fund will open new investment opportunities to allocators.