Nowhere to hide

Ex­cept maybe in the hedge

Finweek English Edition - - News -

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.

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