Hedge funds provide protection against the sharp selloff on JSE
Despite criticism of this asset class, investors would benefit from diversity and lower volatility
There has been much negative press about hedge funds in SA. A key aspect that has been overlooked is that despite a sharp selloff in the FTSE/JSE all share index in 2018, a number of hedge funds have provided significant downside protection, reduced volatility and are positive year to date.
In early August, a prominent hedge fund allocator condemned the SA hedge fund space and stated that it was abandoning all hedge funds. Since then the SA equity market and that particular investment house’s exchange-traded fund (ETF) have fallen by close to 9% while the Hedgenews Africa single-manager composite is positive over the same period, indicating that sometimes you get what you pay for.
From 1900 to the end of 2016 the SA market was the world’s best-performing market, delivering an average annual return of inflation plus 7.2%, according to the 2017 edition of the Credit Suisse Global Investment Returns Yearbook. It compared the returns of various asset classes over 117 years in 21 countries with a continuous investment history. This ongoing overall upward trend has understandably made many SA investors complacent.
In September and October there was a sharp selloff in the market, giving back not only August gains but extending the year-to-date loss to 10%.
It is understandable that SA investors who became accustomed to an upward trending market would after three years of sideways movement begin to question the status quo. This has resulted in major shifts in asset allocations from aggressive and multiasset funds to income-producing, cash-like products.
However, one could argue that the timing of retail investors is wrong considering the value offered by SA equities. History suggests that buying stocks at these low levels has yielded positive long-term returns for investors. The SA small- and mid-cap sector, for instance, has not just moved sideways but suffered significant losses over the past few years, so much so that this segment appears deeply discounted.
While the rest of the world has been getting more expensive, small- and mid-cap SA stocks have been getting progressively cheaper. Impatience and volatility of returns can be investors’ worst enemies, causing them to deviate from longterm investment plans that invariably include a large allocation to risk assets such as domestic equities.
Although the past three years have been tricky to navigate for all managers in SA, the Alpha Prime Equity Hedge QIHF (qualified investor hedge fund) has managed to outperform the market since its inception in 2006 (net of all fees) and was positive to the end of October.
Even more impressive is that this has been done with 60% less volatility, which equates to fewer negative months and smaller losses.
The net effect is that investors that made regular use of hedge funds have not only been able to allocate a larger portion of their assets to growth investments without taking on additional risk but have also been more likely to remain invested due to the lower volatility experienced. This will ultimately improve the probability of their achieving their investment goals.
Instead of moving away entirely from risk and growth assets to cash-like products, a more prudent option would be to include a select number of quality hedge funds that can still capture the upside in a very discounted market while protecting against the kind of sharp drawdowns witnessed recently.
The hedge asset class includes strategies that are completely uncorrelated to equity market performance by trading commodities and fixed income, thereby offering true diversification in one’s overall portfolio.
The key is to understand what you are buying.
Instead of excluding hedge funds altogether, rather engage the assistance of a professional fund of funds house that has evaluated and combined these various strategies in an effective way. This will allow you to become more familiar with the asset class and create a more diversified portfolio without sacrificing returns.
HOWEVER, ONE COULD ARGUE THAT THE TIMING OF RETAIL INVESTORS IS WRONG CONSIDERING
THE VALUE OFFERED BY SA EQUITIES
THE HEDGE ASSET CLASS INCLUDES STRATEGIES THAT ARE COMPLETELY UNCORRELATED TO EQUITY MARKET PERFORMANCE