Gate opens for in­vestors

New reg­u­la­tions mean that a wider group of in­vestors can ben­e­fit from hedge funds and they are not as risky as many peo­ple think,

Financial Mail - Investors Monthly - - Feature: Hedge Funds - writes Jo­hann Barnard

The attraction of hedge funds is to pro­duce a re­turn that is not cor­re­lated to the move­ments in the mar­ket

Hedge funds: Vil­i­fied. Feared. Mis­un­der­stood. Ev­ery­one has an opin­ion on th­ese instruments, which have var­i­ously been pro­claimed as the source of great wealth — some­times for the in­vestor, of­ten for the fund man­agers — or ex­treme losses when they turn out to be noth­ing less than a Ponzi scheme.

No dis­cus­sion on the sub­ject is com­plete with­out ref­er­ence to the great­est scam of them all: Bernie Mad­off’s fleec­ing of in­vestors out of an es­ti­mated US$64bn. One needn’t look too far to find other ex­am­ples of fraud­u­lent ac­tiv­ity pos­tur­ing as a hedge fund that promised great wealth for in­vestors.

Cast­ing about for such cases, one need not ex­tend much beyond the bor­der of the US. The hedge fund in­dus­try there is un­reg­u­lated, cre­at­ing an en­vi­ron­ment ripe for the pick­ing.

Which is a key dif­fer­en­tia­tor for South African in­vestors. The coun­try has a strictly reg­u­lated hedge fund in­dus­try which has re­cently been opened to re­tail in­vestors.

This move has the po­ten­tial to rev­o­lu­tionise in­vest­ing in SA, where pre­vi­ously only wealthy in­di­vid­u­als and in­sti­tu­tional in­vestors could take ad­van­tage of hedge funds.

In­di­vid­u­als can now in­vest in so-called re­tail hedge funds in much the same way as they do in unit trusts.

This is thanks to new reg­u­la­tions re­leased by the Fi­nan­cial Ser­vices Board that place th­ese funds un­der the au­thor­ity of the Col­lec­tive In­vest­ment Schemes Con­trol Act.

Th­ese reg­u­la­tions cat­e­gorise th­ese hedge funds as ei­ther a qual­i­fied in­vestor or re­tail in­vestor hedge fund. The for­mer is still re­stricted to in­vestors with a min­i­mum of R1m to in­vest and

has dif­fer­ent risk re­stric­tions.

The re­tail in­vestor hedge funds, which re­quire a min­i­mum in­vest­ment of R50,000, hold the great­est po­ten­tial for growth for the in­dus­try as the lower thresh­old opens up a mar­ket that was pre­vi­ously barred from hedge funds.

And space to grow is one thing the in­dus­try is not short of. By the end of last year, there was R62.1bn in as­sets un­der man­age­ment com­pared to R1.9 tril­lion in col­lec­tive in­vest­ments schemes as a whole.

In­dus­try par­tic­i­pants are cau­tiously op­ti­mistic that th­ese num­bers will grow as in­vestors and in­de­pen­dent fi­nan­cial ad­vis­ers be­come more fa­mil­iar and com­fort­able with hedge funds as a suit­able tool to di­ver­sify their port­fo­lios.

“The in­tro­duc­tion of re­tail hedge funds is re­ally im­por­tant for the in­dus­try as it gives this as­set class a level of cred­i­bil­ity it didn’t have pre­vi­ously and is not seen in the same light as a unit trust,” says Alexia Kobusch, MD of Nau­tilus MAP.

“It also pro­vides ac­cess to a suite of as­sets we didn’t have be­fore, and gives in­vestors ac­cess to an as­set class they didn’t have be­fore.

“I think that in­ter­est in re­tail hedge funds will grow once the in­de­pen­dent fi­nan­cial plan­ners (IFPs) have com­fort in them and un­der­stand them well enough to sell them. The IFPs have largely been the gate-keep­ers for re­tail in­vestors, who have been guided by their ad­vis­ers on the most ap­pro­pri­ate prod­ucts based on their risk pro­file.”

Once ini­tial ap­pre­hen­sion is over­come, the ease of in­vest­ing in th­ese funds by way of a monthly debit or­der may open the flood­gates.

Kobusch says while up­take may ini­tially be quite slow, this could well change into a steady flow as the ben­e­fits are bet­ter un­der­stood.

“Some of the hedge fund man­agers have started sell­ing them quite ag­gres­sively, and I think that as the prod­ucts are seen as more main­stream and palat­able they will grow quite quickly,” she says.

The re­sponse from the in­dus­try is also key to hedge funds be­com­ing more main­stream. Hedge fund man­agers have tra­di­tion­ally op­er­ated on monthly liq­uid­ity — mean­ing that no­ti­fi­ca­tion to exit an in­vest­ment re­quired a month’s no­tice.

This has cer­tain ad­van­tages for the fund man­agers as they have a longer time hori­zon and abil­ity to free up cash flow to set­tle with the in­vestor.

Kobusch says that should fund man­agers be re­quested to pro­vide daily liq­uid­ity in their re­tail hedge funds, as is the case with unit trusts, this may re­quire them to hold more cash in their port­fo­lios and could in­flu­ence their as­set al­lo­ca­tion de­ci­sions.

“They far pre­fer monthly liq­uid­ity as they’re able to run their book more ef­fi­ciently. And although the in­dus­try tends to trade its books ac­tively, it is easier to man­age cash flows when you have a month time frame within which to work. Also, it is easier to cal­cu­late per­for­mance fees on a monthly ba­sis rather than on shorter pe­ri­ods.”

Th­ese con­sid­er­a­tions and pos­si­ble im­pact on re­turns are clearly im­por­tant to the in­dus­try.

And con­trary to pop­u­lar be­lief, the re­turns from hedge funds are not nec­es­sar­ily su­per-re­turns. Ac­cord­ing to re­ports from HedgeNews, its Africa long/short eq­uity in­dex made a re­turn of 17.1% for one year to the end of December 2015, 15.1% over five years and 14.5% over seven years. In con­trast, the JSE all share in­dex re­turned 5.1% for the 12 months ended December 2015, 13% for five years and 16.4% over seven years.

Kim Hub­ner of Lau­rium Cap­i­tal says the attraction of hedge funds is to pro­duce a re­turn that is not cor­re­lated to the move­ments in the mar­ket.

“Long-only fund man­agers an­a­lyse stocks and make de­ci­sions to buy, sell or hold. Hedge funds can use lever­age and other strate­gies such as short­ing,” she says.

“The abil­ity to go long and short is a big ad­van­tage of a hedge fund. So while the in­vest­ment uni­verse is sim­i­lar, long-only funds try to se­lect shares that they hope will gain in value. In a hedge fund you can also short shares that you be­lieve may de­cline in value, which means that you can profit from shares that go up and shares that go down, pro­vided you get your in­vest­ment calls right.”

She says the Lau­rium Long Short Fund has beaten the Alsi by 2% a year since in­cep­tion in 2008 af­ter fees, at half the risk of the Alsi. Against all the mul­ti­funds that meet pen­sion fund com­pli­ance reg­u­la­tions, only one has had slightly higher re­turns at a sim­i­lar risk pro­file.

Hedge fund man­agers point out that this type of in­vest­ment has to form part of a wider port­fo­lio. Ex­po­sure to a sin­gle as­set class or in­vest­ment style is flirt­ing with dis­as­ter.

“In­vestors have to con­sider hedge funds as part of a suite of as­sets in their port­fo­lio,” Kobusch cau­tions. “Given the dif­fer­ent strate­gies ap­plied by the hedge fund man­agers, such an in­vest­ment re­mains ap­pro­pri­ate ir­re­spec­tive of whether you’re ap­proach­ing re­tire­ment or only start­ing out on your in­vest­ment jour­ney.

“The ad­van­tage is that hedge funds of­fer a re­turn un­cor­re­lated to the mar­ket — so, in a bear mar­ket, for ex­am­ple, it could be more ap­pro­pri­ate than a long-only strat­egy.”

Only time will tell how big an ap­petite lo­cal in­vestors de­velop for th­ese al­ter­na­tive in­vest­ments. But they can rest as­sured that the reg­u­la­tory en­vi­ron­ment has been pro­vided to pre­vent the likes of Mad­off rear­ing their ugly heads.

The in­tro­duc­tion of re­tail hedge funds is im­por­tant for the in­dus­try as it gives this as­set class a level of cred­i­bil­ity

Alexia Kobusch … New cred­i­bil­ity

Kim Hub­ner … Va­ri­ety of strate­gies

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