The past few years have been challenging for the hedge fund industry, with assets declining in 2017 and 2018. Extreme market and currency volatility impacted the performance of hedge funds and they lost favour with investors. However, 2018 was a year that hedge funds came back into their own again and proved why they should be included in part of an overall long-term investment strategy. The All Share Index was down -8.5% last year, while the Hedge News Africa South African Single-Manager Composite was up 5.2% after fees.
One of the major reasons to have hedge funds as an investment is for downside protection and diversification. One only needs to look at the financial crisis in 2008-2009 to see how hedge funds performed as evidence of this. From 1 August 2008 to 28 February 2009, the FTSE/JSE All Share Index (TR) experienced a maximum drawdown of -32%, versus the average South African General Equity fund max drawdown of -26%, and average South African Multi-Asset High Equity Fund max drawdown of -11%. The average Long Short Hedge Fund over this same time, limited its maximum drawdown to -9%. Hedge Funds tend to protect investors from themselves - if they choose to sell at the bottom of any crisis they should limit their losses.
Hedge funds are a lot more complex than traditional long only funds. The industry needs to educate advisors and investors regarding the value proposition of hedge funds and to dispel the myriad of misconceptions that surround them. In addition to this, for the industry to grow, the Financial Sector Conduct Authority (FSCA) should evaluate amending the CISCA regulations to allow for traditional unit trusts to invest in hedge funds. Institutional Pension funds can invest up to 10% in hedge funds, and CISCA should be in line with this to allow retail investors the same opportunity.
Some hedge fund managers have moved their hedge funds from monthly pricing and dealing to daily pricing and dealing, which means that they can now be added onto LISP platforms and included in model portfolios, making them more accessible to retail investors. However, what is still missing is a hedge fund classification framework, which will assist adding the funds onto platforms. This will help advisors and investors to better understand the investment strategy of the manager and fund.
Hedge funds are obviously not without risk, as history internationally has shown. Fortunately, hedge fund managers in South Africa 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, which should give investors comfort. In time, we hope that they will be viewed as another unit trust category that offers investors diversification, downside protection and an opportunity to generate real returns where uncorrelated main stream long only products fall short.