A dif­fi­cult year

Se­lect­ing the cor­rect hedge fund to match the risk pro­file

Finweek English Edition - - Focus On -

“IDON’T LIKE LOSSES, sport. Noth­ing ru­ins my day more than losses,” says Gor­don Gekko, Wall Street’s most in­fa­mous movie char­ac­ter. For those in the hedge fund in­vest­ment sec­tor this year has cer­tainly been one of losses, with more ca­su­al­ties set to come.

De­spite that there are some hedge funds that have per­formed pos­i­tively in con­trast to the gen­eral mar­ket, as one of the over­all ob­jec­tives of hedge funds is to achieve re­turns un­cor­re­lated to the rest of the mar­ket. Those funds cur­rently feel­ing the pain would be those that are highly cor­re­lated to eq­uity per­for­mance and some are record­ing large and very pub­lic cap­i­tal losses.

“If an in­vestor se­lects the cor­rect hedge fund that matches his risk pro­file, then the prob­a­bil­ity of things go­ing wrong are small,” says Louis Bekker, multi-man­ager at BJM. “The man­date of the fund is ab­so­lutely key and the risk/re­turn pro­file of the fund must suit that of the in­vestor. You must con­sider whether the fund is adopt­ing a long/short strat­egy, a mar­ket neu­tral ap­proach, is it a fixed in­come fund or a multi-strat­egy fund where the man­date is ex­tremely wide and strad­dles all the as­set classes. One of the most im­por­tant things an in­vestor de­cid­ing to opt for a hedge fund can do is to go through a fund of funds where the risk pro­file would be more ap­pro­pri­ate to him than a sin­gle man­ager fund.”

Bekker says con­trary to pop­u­lar be­lief that all hedge funds are acutely high risk there are some very con­ser­va­tive hedge funds avail­able, such as those in the fixed in­come cat­e­gory that have posted the most pos­i­tive re­turns of all hedge funds this year. “Hedge funds are be­com­ing more ac­cept­able as an in­vest­ment av­enue, and off­shore pen­sion funds are even allocating 30% to 45% of their weight­ings to such funds.”

Hedge funds are of­ten viewed as a “black box,” with in­vestors hav­ing no idea where their funds are be­ing al­lo­cated and what the per­for­mance is un­til they hear hor­ren­dous me­dia re­ports of their mas­sive losses. Bekker says the op­po­site is true. “If re­quested, fund of hedge fund man­agers can re­ceive daily re­ports of their hold­ings and can iden­tify at any time where the risk ex­po­sures are. That’s un­like a con­ven­tional unit trust, where re­port­ing is monthly and some­times even quar­terly for the more detailed in­sights.

“Hedge fund in­vestors are able to see ex­actly where their al­pha (out­per­for­mance to the bench­mark) is com­ing from. All of the rep­utable fi­nan­cial in­sti­tu­tions of­fer­ing hedge funds would have es­tab­lished com­pli­ance and risk com­mit­tees and the in­vest­ment de­ci­sions and strate­gies of the man­agers are con­stantly mon­i­tored and in the finest de­tail.”

Bekker says for those in­vestors who want to be in hedge funds the al­lo­ca­tion should be around 10% to 15% of their to­tal port­fo­lio. “But be­fore run­ning into such funds the use of a fi­nan­cial ad­viser is highly rec­om­mended. Fi­nan­cial ad­vis­ers will con­struct a fi­nan­cial plan that meets the unique risk re­turn re­quire­ments of a client to en­sure the client is not overly ex­posed to a sin­gle as­set or in­vest­ment. The risks can be enor­mous if you go into an in­ap­pro­pri­ate fund or with the wrong weight­ing com­pared to the rest of your as­sets and the fees a plan­ner may charge would be worth it.”

For those mov­ing to the high-risk end of the hedge fund spec­trum the pri­vate eq­uity and com­mod­ity hedge funds (where re­turns

in 2008 have been ex­cep­tional) prom­ise the great­est al­pha. How­ever, sig­nif­i­cant volatil­ity risks do come from the heavy gear­ing and na­ture of the fi­nan­cial in­stru­ments used in their strate­gies. Bekker says an in­vestor may want to al­lo­cate a 2% to 3% weight­ing to those higher risk funds. But again, that’s de­pen­dent on the in­vestor’s risk pro­file and should be done with the as­sis­tance of a fi­nan­cial ad­viser.

A fund of hedge funds would re­quire a min­i­mum in­vest­ment of around R50 000 to R100 000, whereas in sharp con­trast the sin­gle man­ager fund min­i­mums would range from R1m to R10m. On the sen­si­tive topic of fees, the an­nual fee is usu­ally 1% flat on the value of the port­fo­lio, but that can go up to 2%. Per­for­mance fees are high and can range from 10% to 20% on the out­per­for­mance of the hur­dle rate.

Bekker says the bench­marks in hedge funds are usu­ally the STeFI (short-term fixed in­ter­est) or inflation plus 5%, some­times even 10%. “Those are very high thresh­olds, and hedge fund man­agers need to be con­stantly per­form­ing if they’re to meet and sur­pass them. Many funds get capped (closed off from fur­ther in­flows) when they reach R400m to R500m. That’s small, but they need to be kept liq­uid in or­der to meet their man­dates and be com­pet­i­tive.

Bekker says the re­main­der of 2008 and pos­si­bly 2009 could re­main volatile, with the high pos­si­bil­ity of more sub­stan­tial losses in the hedge fund in­dus­try and in­vestors shouldn’t try and “go it alone”.

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