Recognise the hazards

Hedge funds have traditionally been reserved for a small segment of SA’s investment community. A minimum investment of R1m sets the bar high for the bulk of the country’s financially savvy investors, writes Johann Barnard.

But now, with the introduction of retail hedge funds that require a minimum investment of R50,000 — which can be topped up with monthly debit order investments — these funds can appear very appealing.

A hedge fund provides protection against market volatility, as the managers can invest in more than equities — which is the case with unit trusts. The fund can invest in bonds, property, currencies and equities. Fund managers can also draw on tools such as leverage and short selling to provide protection against wild market swings.

These tools and strategies would be foreign territory to the average investor, who is at risk of making an ill-advised decision without an understanding of the risks involved. Independent financial advisers (IFAs) also may not yet be fully qualified to make an informed call on whether a specific hedge fund offers the right solution.

“This is uncharted territory for the industry and investors,” says Grant Mann, operations manager at 36One Asset Management. “A lot will depend on the education of the market and on investors becoming more comfortable with hedge funds over time.” Mann says these funds “aim to protect on the down side. They don’t guarantee that there will not be losses but they are better equipped to manage and minimise the losses. Investing in hedge fund strategies can help investors improve their risk-adjusted return profile … . Our hedge funds have produced their best relative returns in weak or negative markets.”

Mann says that 36One expects most inflows will be from fund of funds and IFAs (on behalf of retail investors) rather than directly from individuals.

As these investment options are still new in the market, it may be a while before hedge fund managers settle on their marketing strategy.

“Top of mind for many investors when it comes to hedge funds is risk. It’s an area where perception can be very different from reality,” says Kim Hubner of Laurium Capital. “Part of our job is to educate and explain the benefits and the risks.

“The new legislation is probably a world first in regulating the hedge fund industry, which makes SA completely different from other markets. It will be important for investors to look for hedge funds with a long, consistent track record backed by an experienced team that has rigorous investment and operational processes. Flows will also depend on hedge funds being made available via linked-investment services provider platforms.”

The education process will need to deal with the fees charged by hedge fund managers. These are generally confined to an administration fee and a performance fee, which can be contentious if not understood properly.

“It is undeniable that hedge funds are more expensive than long-only products. To manage a hedge fund requires a far different skills set than for a long-only fund, and you need to be well qualified to do that.

“So a premium can be charged for it,” says Hubner.

“It is important to understand how performance fees are charged. Laurium uses series accounting, which means investors are not paying for past performance that they have not benefited from, as is the case with many unit trusts. And performance fees are subject to a high water mark; the manager does not get paid for poor performance — if the manager loses money over a certain period, he needs to get the fund above the high water mark before taking a performance fee.”

Mann points out that many unit trust managers, too, levy fees based on the fund’s performance.

Glen Baker, head of alternative investments at Anchor Capital, says criticism of fees is not entirely unwarranted, but apple-for-apple comparisons need to be made. “Management fees, for example, need to be compared with other providers in the collective investment space. Excessive fee structures which may have occurred in the unregulated space will be shaken out in the collective investment scheme world.

“Performance fees get paid only if the manager provides a suitable risk-adjusted return profile to the client.”

It will take time for these hedge funds gain the interest conventional collective investment schemes enjoy.

They could attract significant inflows when that level of comfort is reached.

Grant Mann … education