Nowhere to hide
Except maybe in the hedge
INVESTORS ARE running for cover. The worst decision by anybody with an equities portfolio they’ve held for more than a year is to sell. But, sadly, some investors are doing that. Private client managers tell me they advise clients that selling shares now only cements losses and they should ride out the storm. But in the end it’s the client’s decision – and some are adamant they want out.
What other options are there? Cash and fixed-interest funds, perhaps as a temporary measure. The only good thing about cash – suddenly the king again – is that South Africa’s relatively high interest rates offer a decent return, at least before tax. But it’s only a short-term strategy: you aren’t going to get any capital growth out of a money market fund.
There are also hedge funds. Those make many investors nervous and are blamed for all sorts of ills, most recently (globally) as promoting “evil” short selling. What hogwash. Taking a view on a share price you expect to decline is a perfectly legitimate strategy and, if paired with views on shares where the price is expected to rise, opens up options for a manager to exploit the market’s ups and downs.
That equity long/short strategy is the most common type of hedge fund found in the South African industry. The only weakness, as I see it, is that many such funds, while using shorting, are too market directional. So they tend to mirror the performance of SA’s equities market.
The latest Novare Investments SA hedge fund survey offers a useful insight into local hedge funds and they certainly don’t look bad. The industry here is growing and attracting positive inflows of investment capital (I suspect soon to be released unit trust statistics will show outflows in many categories). The Novare survey only looks at rand-denominated and SA-domiciled hedge funds but reckons that covers at least 90% of the SA industry.
Total assets under management (for the year to end-June) increased to R30,3bn from R25,9bn in the previous year. Some 20 new hedge funds were launched but 21 were discontinued, with money returned to investors. Novare sees that as consolidation in the industry.
Net inflows stood at R6,3bn (R7,1bn in 2007) – not bad for a year when everybody was nervous about the market. But who are these investors?
Top of the list is funds-of-hedge-funds (FOHF), probably the most sensible route for an individual investor, as you have diversity of funds and styles and a professional selecting and monitoring the funds. FOHFs are also more affordable – single mandate funds don’t often take investments of less than R1m.
Surprisingly, high net worth individuals are the second largest group of investors in hedge funds. The percentage of wealthy individuals has fallen to 9% (of industry assets) from 18,2% the previous year. However, Novare doesn’t believe that’s part of a new longer-term trend. Third largest investors are pension and life funds, which may surprise some people – even if you don’t like hedge funds you probably have exposure to them.
What’s encouraging to read in the survey is that hedge fund managers representing 75% of industry assets co-invest in the funds they run. It’s always a good sign when the fund manager invests in the fund and is the first question prospective investors should ask when considering a hedge fund.
What tends to scare people about hedge funds is leverage, or gearing. According to the survey, SA funds do gear but are quite responsible about it. For example, only 3% of the funds covered in the survey use external cash borrowings to gear. Most (68%) use futures contracts or derivatives for leverage, and 62% use scrip lending, mainly for shorting. The average level of leverage throughout all hedge funds measured as a percentage of assets leveraged more than twice the capital in the fund is 24%, down from 36% in the previous year.
But what about performance? It’s not a good measure of hedge funds: some deliberately sacrifice performance for capital protection. But investors want to know about performance.
Almost a third of the funds had a negative return in first quarter 2008, which supports my view that the weakness in the industry here is that too many of the long/ short funds are market directional. For the year the average return across all the hedge funds was “marginally positive,” says Novare, but adds there’s wide dispersion in returns. For example, over the year the fixed interest arbitrage funds had positive returns ranging between 10% and 25%.
So if investors are nervous – and sensible about their choices – they might find that hedge funds are the place to hide in this stormy market.