Hedg­ing your bets

Hedge funds are a good way to di­ver­sify your risk, writes Jo­hann Barnard

Financial Mail - Investors Monthly - - Feature: Hedge Funds -

An in­vest­ment port­fo­lio’s abil­ity to pro­duce above-mar­ket re­turns is al­ways due to a com­bi­na­tion of fac­tors. For ad­vo­cates of hedge funds, the prom­ise is gen­er­ally for re­turns counter to mar­ket con­di­tions.

This is ob­vi­ously a sim­pli­fi­ca­tion of com­plex strate­gies that fund man­agers em­ploy to de­liver re­turns based on their con­vic­tions about dif­fer­ent sec­tors, as­set classes and in­di­vid­ual coun­ters. Their big sell­ing point, how­ever, is the prom­ise of su­pe­rior re­turns com­pared to the rest of the mar­ket.

This prom­ise does come with an im­por­tant caveat — par­tic­u­larly for in­vestors who could be clas­si­fied as re­tail. And that is that hedge funds cer­tainly of­fer a proven method of risk di­ver­si­fi­ca­tion, which should al­ways be em­ployed within the con­text of a broader port­fo­lio of other di­verse as­sets.

“The only free lunch in in­vest­ing is di­ver­si­fi­ca­tion,” says Pe­ter Ur­bani, of San­lam’s hedge fund busi­ness, Blue Ink In­vest­ments. “Where they come into their own is as an al­ter­na­tive source of al­pha. How­ever you view what they’re do­ing, in an ideal world they pro­vide you with a di­ver­si­fi­ca­tion ben­e­fit.”

He cites the 2008 fi­nan­cial cri­sis that sparked a 50% col­lapse of eq­uity mar­kets, whereas hedge funds were down by an al­most-palat­able 20%. The rel­a­tive per­for­mance of hedge funds in ex­treme crises is of­ten given as jus­ti­fi­ca­tion for their ex­is­tence.

But fig­ures pro­vided by Ur­bani for Blue Ink’s com­pos­ite hedge fund in­dex over the past three years to end-April show that a hedge fund doesn’t need a cri­sis to out­per­form. The in­dex shows that, on av­er­age, SA hedge funds pro­duced com­pound an­nual growth of 8.73% com­pared to the FTSE/JSE all share in­dex of 6.32%, and the 4.3% of the Asisa SA EQ gen­eral bench­mark.

Blue Ink’s re­turns, how­ever, be­lie the chal­leng­ing con­di­tions that hedge fund man­agers have been ex­pe­ri­enc­ing.

Alexia Kobusch, MD of Nau­tilus, says she is con­cerned about how fund man­agers are go­ing to make their re­turns.

“The mar­ket has been tough for port­fo­lio man­agers this year. Mar­ket volatil­ity has been muted, which means the abil­ity to make short-term gains has been chal­leng­ing. Be­cause of the po­lit­i­cal un­cer­tainty lo­cally and abroad, the mar­ket hasn’t re­ally been trad­ing on fun­da­men­tals ei­ther,” she says.

“Some guys are get­ting it right, but be­cause of the muted volatil­ity this is not in any way dif­fer­ent from a long-only man­ager,” Kobusch adds. “So the prob­lem is that even though you have the abil­ity to go short, if the mar­ket isn’t mov­ing at all, it’s ir­rel­e­vant.”

Ur­bani ar­gues, in con­trast to this view, that there is a high dis­per­sion of re­turns in the eq­uity long-short space, depend­ing on the skills of the fund man­agers.

“But when you look at the range of that dis­per­sion com­pared to long-only eq­uity man­agers, the worst of the hedge funds are still sig­nif­i­cantly bet­ter than even the bot­tom quar­ter of the gen­eral equities. And the best are much higher.”

He does con­cede that some funds may un­der­per­form over shorter pe­ri­ods, but says the ad­van­tage hedge funds have is the abil­ity to pro­vide asym­met­ric re­turns com­pared to lon­gonly in­vest­ments.

Kim Hub­ner of Lau­rium Cap­i­tal shares the views of Ur­bani and Kobusch re­gard­ing the va­garies of cur­rent mar­ket con­di­tions and the vari­able per­for­mance of lo­cal hedge funds.

Last year was “a very dif­fi­cult year for many hedge funds due to the im­pact of un­pre­dictable macro fac­tors.

“It’s about how you man­age your risk. Macro fac­tors are dif­fi­cult to pre­dict, but you have to have a view re­gard­less. How­ever, most of what we do is bot­tom-up stock-pick­ing, and that is where we spend most of our time. In ad­di­tion to this, we look for spe­cial sit­u­a­tions and trad­ing op­por­tu­ni­ties that can add ad­di­tional al­pha.

“Over the long term, hedge funds have done what they set out to do in terms of pro­tect­ing cap­i­tal and giv­ing clients de­cent re­turns,” Hub­ner says.

Ac­cord­ing to Lau­rium, over a 10-year pe­riod, from Jan­uary 1 2007 to De­cem­ber 31 2016, long-short eq­uity funds (peer group av­er­age as mea­sured by HedgeNews Africa) had an an­nu­alised re­turn of 10.8% af­ter fees, com­fort­ably beat­ing the av­er­age SA Gen­eral Eq­uity Fund and SA Multi-As­set High Eq­uity Fund, which re­turned 8.8% and 8.6% re­spec­tively. The FTSE/JSE all share (TR) over the same pe­riod had an an­nu­alised re­turn of 10.4%.

Over the fi­nan­cial cri­sis (Au­gust 1 2008 to Fe­bru­ary 28 2009), the FTSE/JSE all share (TR) had a max­i­mum draw­down of -32%, com­pared to the av­er­age SA Gen­eral Eq­uity Fund of -26%, and av­er­age SA Multi-As­set High Eq­uity Fund max draw­down of -11%. The av­er­age long-short fund over this same time only had a max­i­mum draw­down of -9%.

The good news for in­vestors is that these ben­e­fits and re­turns are now eas­ily ac­ces­si­ble through the re­tail hedge funds that have been reg­is­tered with the Fi­nan­cial Ser­vices Board. How ap­pro­pri­ate these are and the ex­po­sure one wants should ob­vi­ously be de­cided in con­sul­ta­tion with an in­vest­ment pro­fes­sional.

Kim Hub­ner of Lau­rium Cap­i­tal

Pe­ter Ur­bani of Blue Ink

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