The in­sti­tu­tional per­spec­tive

It can be an in­de­pen­dent source of re­turn and a tool for over­all risk re­duc­tion.

Finweek English Edition - - Alternative Investments -

THE PRI­MARY LONG-TERM goal of a re­tire­ment fund is to pro­vide its mem­bers with a de­cent in­come at re­tire­ment. An ap­pro­pri­ate strate­gic as­set al­lo­ca­tion rep­re­sent­ing the per­cent­age weight­ing of as­sets among the dif­fer­ent as­set classes – eq­ui­ties, bonds, prop­erty, cash and off­shore in­vest­ments – is key to meet­ing mem­bers’ ex­pec­ta­tions.

Fa­tima Vawda, MD of 27four In­vest­ment Man­agers, says that with more than 90% of the in­vest­ment per­for­mance of a re­tire­ment fund be­ing driven by as­set al­lo­ca­tion, the im­por­tance of an ap­pro­pri­ate as­set mix is crit­i­cal.

“In South Africa, Reg­u­la­tion 28 of the Pen­sion Fund Act re­stricts and de­ter­mines the ex­po­sures to the dif­fer­ent as­set classes. Cur­rently, hedge funds fall within the ‘other’ as­set class cat­e­gory and lim­ited to a max­i­mum al­lo­ca­tion of 2,5%. The Act is cur­rently un­der re­view and may be amended to in­crease the al­lo­ca­tion to hedge funds but for the time be­ing in­creased ex­po­sure to SA hedge funds can be achieved through vari­able rate deben­ture type struc­tures.”

Vawda says pen­sion funds have be­come in­creas­ingly aware of the need to di­ver­sify their sources of re­turn and re­duce their risks. “Funds in­vested pri­mar­ily in eq­ui­ties and bonds – as most typ­i­cally are – tend to strug­gle in bear mar­kets as the value of their as­sets drop and their li­a­bil­i­ties in­crease due to the fall in bond yields. Hedge funds, if used ef­fi­ciently, can be an in­de­pen­dent source of re­turn – a buf­fer against volatil­ity and a tool for over­all risk re­duc­tion.”

To cor­rect com­mon mis­con­cep­tion Vawda says hedge funds aren’t a sep­a­rate as­set class. “They merely present a col­lec­tion of in­vest­ment strate­gies that in­vest in main­stream as­set classes, de­fined by two un­derly- ing di­men­sions: skill and style.”

Vawda says hedge fund in­vest­ing holds spe­cial risks and spe­cial ben­e­fits. “A hedge fund port­fo­lio should con­tain prop­er­ties suited to that re­tire­ment fund, As with any in­vest­ment you should know un­der what cir­cum­stances the in­vest­ment will un­der­per­form and in par­tic­u­lar what fac­tors the in­vest­ment is ex­posed to – for ex­am­ple, liq­uid­ity and size – to en­sure any un­de­sir­able ex­po­sures are min­imised at the over­all fund level. Cer­tain styles of hedge funds make very good di­ver­si­fiers of ‘long’ eq­uity port­fo­lios un­der all mar­ket con­di­tions and some don’t.

“Low risk hedge funds – such as mar­ket neu­tral or rel­a­tive value fixed in­come – could be in­tro­duced as part of the de­fen­sive por­tion of an in­vest­ment strat­egy or as part of or as an al­ter­na­tive to the fixed in­come al­lo­ca­tion. Long/short eq­uity hedge funds could be used along­side the long-only eq­uity al­lo­ca­tion for the pro­vi­sion of ‘in­sur­ance’ or ‘down­side pro­tec­tion’ or even re­turn en­hance­ment. An adept fund of funds man­ager will en­sure a good ‘pro­tec­tive’ blend of man­agers in the over­all hedge fund port­fo­lio.”

Vawda says trustees should avoid over­ex­po­sure to any sin­gle man­ager. “In the event of a ‘blow-up’ an over­ex­posed al­lo­ca­tion will af­fect the per­for­mance of the fund of funds. Off­shore, this year has seen a se­ries of hedge fund blow-ups due to the sub-prime cri­sis, where banks pulled lever­age or in­vestors de­manded their money back from illiq­uid strate­gies.

“Trustees must also un­der­stand the fund’s with­drawal (liq­ui­da­tion) terms and con­di­tions. Many funds of hedge funds, mostly those off­shore, ap­ply re­stric­tive gates, mak­ing it dif­fi­cult to ac­cess funds – par­tic­u­larly dur­ing a panic pe­riod when funds can’t achieve the liq­uid­ity to meet the re­demp­tions.

“In­vestors must also un­der­stand the level and na­ture of the lever­age be­ing ap­plied at the un­der­ly­ing man­ager and fund of fund level and be wary of funds of hedge funds that have di­rect own­er­ship in un­der­ly­ing funds. The ques­tion in this case is whether they al­lo­cate across their in­ter­nal hedge funds in a way that’s adding value and free of con­flicts? Other key con­sid­er­a­tions are whether there’s re­ward for the

higher fees be­ing charged and does the fund make use of an in­de­pen­dent risk man­ager and ad­min­is­tra­tor?”

Vawda says fund of hedge funds have per­formed poorly in SA this year, with most man­agers de­liv­er­ing neg­a­tive re­turns yearto-date – de­spite us­ing cash as their hur­dle rate. “The av­er­age re­turn year-to-date endJuly was –1,30%, with the high­est at 3,36% and the low­est at –6,74%. Funds that did well dur­ing the bull mar­ket suf­fered dur­ing that volatile pe­riod. Of­ten, in a multi-man­ager con­text, fund of fund man­agers tend to be re­ac­tive ‘af­ter the event’ than cater for that rare or ran­dom event all the time.

“Also, the abil­ity to change port­fo­lios is slow, as most of­ten un­der­ly­ing man­agers pro­vide 60-day liq­uid­ity terms and that makes it dif­fi­cult for fund of fund man­agers to re­act quickly to chang­ing cir­cum­stances.”

The im­por­tance of an ap­pro­pri­ate as­set mix is crit­i­cal. Fa­tima Vawda

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