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,
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