Hedge funds struggle to regain investor confidence
Industry remains a target for criticism by those who misunderstand its vital role in mitigating investment against risk and volatility
The past few years have not been smooth sailing for the hedge fund industry as it adjusts to new legislation and counters criticisms of high fees and poor performance.
The original idea behind hedge funds was to offer investors protection against downside volatility. High-profile hedge fund failures internationally, however, have added to the perception that hedge funds are inherently risky. The industry’s first decline in assets under management since 2011 was in 2017, as many investors chose to align with more traditional investment vehicles.
The term hedge fund encompasses a heterogenous industry and a broad collection of investment strategies including leverage and shorting financial instruments. As such, says Richard Simpson, portfolio manager at Obsidian Capital, hedge funds need to be judged on an individual case by case basis, not stereotyped. “While there are hedge funds that may not have delivered on their promises, are expensive and too complicated, there are many successful hedge funds that are worth investigating: funds that are not out to pull the wool over investors’ eyes and are run by hard-working, honest and skilled people,” says Simpson.
Ever since the first hedge fund was launched in 1949, many have managed to offer downside protection and reduce volatility, says Jean Pierre Verster, portfolio manager of Fairtree’s Protea range of hedge funds. However, the potential for generating above-average returns — and fees — has attracted thousands of would-be hedge fund managers to the industry which, he says, has decreased the average return of hedge funds as a group, to some extent obscuring the benefits of investing with a skilled hedge fund manager over the long term.
The industry maintains that hedge funds are a misunderstood investment vehicle. There are a myriad misconceptions about hedge funds. Some of the most popular include the fact that the average hedge fund performance is representative of all hedge fund performance; that hedge fund performance fees are bad for The industry remains the best option for investors seeking protection against downside volatility despite criticism investors; that short-selling is either always immoral or a moral crusade; that short-selling causes price collapses; and that hedge fund managers are all short-term traders, among others.
The misconception that hedge fund managers are risk-seekers using irresponsible levels of gearing is one that has been perpetuated by mass media seeking to dramatise the average hedge fund manager, says Murray Winckler, co-founder and portfolio manager at Laurium Capital. “The reality is that most SA hedge fund managers are conservative long-term investors, invested alongside their investors in the same funds, with capital preservation and inflation beating returns as their main focus,” he says.
Another common misconception is that hedge fund managers promote corporate behaviour that has a short-term benefit for the share price but create long-term problems for the underlying businesses.
Justin Cousins, executive director at Peregrine Capital, says: “We pride ourselves on understanding the underlying mechanics of the instruments we buy and those that we sell short, and where appropriate, we engage constructively with management teams to promote long-term sustainable growth of the businesses that we invest in.”
There’s a widely held view that hedge funds are risky investments but it’s impossible to comment on hedge funds as a homogenous investment category, says Cousins. “Macro hedge fund strategies differ from long/short strategies, which also differ from market-neutral strategies,” he says. “Some hedge funds focus only on fixed income instruments where others specialise in commodities or equities. There are numerous examples of successful hedge funds in each strategy and product category, both locally and internationally, just as there are as many examples of failed hedge fund businesses.”
If managed correctly, says Erik Nel, chief investment officer at Terebinth Capital, hedge funds should provide protection against adverse market conditions, and thus by default, should not be expected to capture all the upside of a beta-driven market rally.
“Albert Einstein once said: ‘Compound interest is the eighth wonder of the world. He who understands it, earns it — he who doesn’t, pays it’. The same can be said for the compounding returns that can be achieved by protecting the downside and focusing on the compounding effect of returns in excess of the
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