Performance over the past number of years has been lacklustre, writes Johann Barnard
It’s been a tough time for the local hedge fund industry, which has had to deal with net outflows of about R5bn in 2017. It follows a rigorous process of transition to the regulated collective investment scheme space that started in 2015.
One reason for the change has been to attract retail investors who want to add more diversification to their portfolios through these alternative investment structures.
The Association for Savings & Investment SA reported in April that this was the industry’s first decline in assets under management since 2011.
There is general agreement that the reason for funds flowing out is lacklustre performance over the past number of years.
Novare Investments’ Neil Verster says performance over the past year has favoured fixed income strategies rather than long-short equity ones. “Having said that, the latter, as well as market-neutral strategies, has protected capital in 2018, while the local equity market is down for the year to date. Manager performance within strategies, however, has been mixed with some performing extremely well whereas others struggled,” he says.
Kim Hubner of Laurium Capital says that while 2018 is looking much better, the industry has had a tricky time.
“The market was tough last year,” she says. “With 50% of returns coming from Naspers, it wasn’t an easy market for most hedge funds. They have, on the whole, not done that well over the past two-and-ahalf to three years.
“From an institutional perspective, the headwinds have been fees, in an environment where performance has been disappointing. With fee transparency [brought about by the Collective Investment Schemes Control Act] questions are being asked about whether hedge funds have delivered sufficient risk-adjusted returns for the fees they have charged.”
These pressures aside, Hubner says local hedge funds have on the whole had a much better year this year, with Laurium’s funds up between 6% and 11% to the end of June — significantly better than the JSE Alsi (-1.7%) and the FTSE/JSE capped shareholder weighted all share index (-5.9%).
Hubner says there is evidence that the hedge funds of funds, in particular, are struggling for the reasons mentioned above, but especially due to newly introduced transparency. “Now that hedge funds have been regulated, investors have more information about the hedge funds themselves and are happy to invest directly, as opposed to going through a fund of funds that comes with an extra layer of fees.”
George Herman of Citadel describes this transparency as an unintended consequence of the regulation.
“The whole effort was to make the industry more trustworthy for retail investors, more transparent and more standardised.
“It was all for very good reasons, but what has come with it is the standardised methodology of reporting on fees. The first time those numbers came out investors had a shock reaction,” he says.
He does not foresee a rapid return of inflows into the funds, as the flows are typically influenced by longer-term, structural, systemic issues.
“The intermediary environment also has a huge role to play, because when [intermediaries] sit with clients one of the biggest factors they put before them is cost. So, the intermediary environment will have to become a lot more sophisticated, and that will probably only happen after we’ve had a crash, when the value of hedge funds is recognised.”
This is a perennial challenge for the industry, one it hasn’t yet managed to overcome.
Hubner says the easiest way to deal with resistance on this issue is to focus on net returns. “We try to avoid looking at fees in isolation, and instead gauge the level of cost in relation to the expected value the investment might add, especially the ability to reduce losses and preserve capital.”
She says hedge funds have by their very nature a higher cost base because of the skills set required to manage them.
“Hedge funds are a lot more complex to manage because there are more moving parts. A long-only manager simply buys stocks he thinks are undervalued. A hedge fund manager employs leverage that can add to your returns, but also your risk, and can short shares as well. Managing liquidity is key, especially on short trades.”
There appears to be no end to this debate, nor to the industry’s attempts to explain the costs being charged.
If it does not manage to win this, its very existence is at stake, which will lead to further consolidation in the market.
Kim Hubner … a tricky time