No longer the market bogeyman
• Hedge funds are coming in from the cold and are a useful diversifier in an investment portfolio
Iexpect that 2017 will be remembered as the year that hedge funds finally became a mainstream retail investment. Financial advisers should all be going on training courses to familiarise themselves with the product — there is no excuse for leaving it out of a product mix.
More brokers should get familiar with leading hedge fund managers such as 36One, Visio, Fairtree and Laurium, which have migrated successfully into offering long-only equity and multi-asset funds.
Let’s be generous and overlook a few stinkers in their 2016 numbers; in the longer term, these are solid houses.
I was interested to see the case for hedge funds put forward by Eugene Visagie. As well as being head of Novare’s hedge fund business he is also head of the industry steering committee. He likes to see himself as the hedge fund mythbuster, though perhaps without the same propensity for loud noise and chaos as those from Discovery.
South African hedge funds, Visagie argues, are not high-risk. In fact, they are quite stodgy and conservative. In the past, the industry was secretive, getting publicity only during a blow-up or fraud case — not that these occasions can be wished away.
Hedge funds are now regulated on the same basis as classic mutual funds as they fall under the collective investment schemes legislation. Since 2007, these managers have had to operate with what is quaintly called a 2A Cat licence.
Are hedge funds risky? The reality is that there is a small chance of not only losing your initial investment, but a multiple of that. Losses on long positions are finite, but when selling a share short, losses are openended. Visagie says that because hedge funds have low correlations to traditional equity and bond portfolios, allocating an exposure to hedge funds can be a good diversifier.
I remember the age-old argument that a hedge fund manager is playing with a full set of golf clubs, while a long-only manager is just playing with a driver and a putter. Hedge fund managers use derivatives, sell shares short and use leverage to extract positive performance in both rising and falling markets.
I am not sure if Visagie has exploded the “myth” that hedge funds charge high fees. Did zillionaires such as Steve Cohen get rich by charging Walmartstyle prices? And why else is a hedge fund shop with R10bn under management nicely profitable, while a long-only shop of similar size would be one client loss away from bankruptcy court? Visagie seems to think that a client paying away 20% (or one-fifth) of his total return is fine because the industry has generously reduced its initial fee from 2% to 1%. If they have the courage of their convictions, hedge fund managers should waive their initial fees and just live on what they kill.
Visagie is on firmer ground on the myth that hedge funds produce big swings in performance. Perhaps the biggest plus of well-managed hedge funds is that they have more tools to protect the portfolio in falling markets. Volatility is lower.
Having gone through the process of registering collective investment schemes to sell to the public, I am not surprised that Visagie wants to explode the myth that hedge funds are only for the rich or for big corporates. More and more pension fund members will get indirect access to hedge funds, which can account for up to 10% of their fund assets. Retail hedge funds aren’t exactly deep retail; the minimum subscription for these funds is anything between R20,000 and R250,000. But it still makes them far more accessible than before.
It is widely thought that hedge funds use exotic assets and investment strategies that aren’t well known. But Visagie argues that at least South African hedge funds invest in the same securities as regular unit trusts, predominantly in bog-standard equities and bonds, with just a pinch of soft commodities.
Hedge funds tend to be managed by boutique managers — of the large shops only Sanlam has a comprehensive suite of hedge fund and fund of fund products. But many of these boutiques are well on their way to turning their businesses into full-service operations. In a few years, Laurium or Visio could be where mid-sized shops such as PSG and Foord sit today.
Globally, the canvas is much larger, but it has helped hedge funds to eke out slightly better returns than the market, even after their exorbitant fees. It might not seem impressive that global hedge funds returned 5.34% (in US dollars) in 2016, but it is quite good in the worldwide search for investment returns.
It is hard to find a good benchmark for global hedge funds but the best proxy I have seen comes from hedge fund research house Evestment. It is very simple but highly relevant: 50% MSCI World and 50% Citi World Government Bond index. This gave 4.74% — and remember the returns of these indices do not take account of fees, while hedge funds quote returns after fees. I am not sure that this is particularly ethical as it means the fees paid are not transparent; hedge funds should publish a gross of fees number as well.
I don’t know who came up with the term “distressed funds” but it isn’t a very sexy term. Presumably, investors are buying the fund because there is a chance of recovery in all the discounted debt in the fund, so why not call it a pending recovery fund or something?
Well, it would have been a mistake to avoid distressed funds because of their unattractive name. They gave a solid 11.5% dollar return in 2016. The other strong performer, but also not available in SA, was activist event-driven funds that engage in activities such as merger arbi- trage with a halo over their heads, returning 10.43% in the process.
Poor performers included managed futures (0.81% for the year), market neutral (1.72%) and multistrategy (2.02%).
There have been a few outsized returns to be found, particularly in emerging markets. China had a poor year, with China-focused hedge funds losing 5.82% in 2016.
But Brazil funds had an outstanding year with a 33.29% return, though this wasn’t nearly enough to offset losses in the prior three years.
Russian hedge funds have been better medium-term performers and after a modestly positive 2015 had a stellar 28.57% return in 2016.
ARE HEDGE FUNDS RISKY? THE REALITY IS THAT THERE IS A SMALL CHANCE OF NOT ONLY LOSING YOUR INITIAL INVESTMENT BUT A MULTIPLE OF THAT