Taking time to understand how funds work is ‘worth the effort’
Although hedge funds have been available in SA since the 1990s, they were initially only available to high net worth individuals and some institutional investors.
That has changed in recent years and hedge funds are now available to retirement funds — via a prescribed allocation to alternative investments — and to retail investors.
Despite the fact that they’ve been around for a while, they remain a misunderstood and misrepresented asset class, insists Asisa’s Hayden Reinders. SA has a number of good active fund managers with a variety of excellent hedge fund products available.
“Unfortunately there remains a stigma in some quarters that hedge funds are restricted to high net worth individuals and institutions. There remains a significant lack of education regarding exactly what a hedge fund is and its role in a diversified portfolio which is something that both Asisa and some of the larger managers are trying to address.”
There are many reasons why hedge funds are still mistrusted to a certain extent, explains Marthinus van der Nest, head of Amplify Investment Partners. “One of the major challenges we come across is that hedge funds are viewed as a black box. The majority of investors struggle to understand the inner workings of a hedge fund and the added complexity associated with these funds creates a great deal of mistrust.”
Dissuading investors from using hedge funds is a concern that they won’t be able to explain the drivers of underperformance to their clients, says Van der Nest. He agrees with Reinders that this can be overcome with education, as well as greater transparency on the part of hedge fund managers.
Taking the time to better understand how hedge funds work is worth the effort, believes Van der Nest, given that they can play the role of a risk diversifier or a return enhancer in a portfolio.
“The hedge funds which are risk diversifiers are those with unique investment strategies with very little relation to equity or other indices. These strategies offer the greatest diversification benefit to a portfolio given that they move in a unique way relative to other asset classes, and serve as an excellent hedge to a traditional long only portfolio during turbulent markets.”
Risk diversifiers, he adds, provide uncorrelated returns which lowers volatility, significantly reduces portfolio drawdowns and enables investors to take more risk overall.
Hedge fund strategies that play the role of return enhancer, on the other hand, are more correlated to the market and combine a mix of beta and alpha in order to provide an outcome that would not be possible through a traditional long only fund, explains Van der Nest.
“In order to benefit from the beta kicker, return enhancers will naturally be more sensitive to market swings and provide returns in excess of the market during a rally, enhancing portfolios with an alpha sweetener.”
The key benefit of a hedge fund product is the ability to protect the downside when markets are selling off, says Nomathibana Matshoba, MD at Terebinth Capital.
“The best a long only portfolio can do is introduce a hedge or completely sell out of a position before a sell-off. Hedge fund products, on the other hand, can benefit from market downturns given the ability to short underlying asset classes. This then becomes a return source during market downturns that can be beneficial in a diversified portfolio,” she adds.
With the exception of 2021, equity returns have been lacklustre the past few years. This is resulting in a healthy appetite for hedge funds, says Van der Nest.
“However, while there is appetite, investors are not well acquainted with the various hedge fund managers or the different strategies available.
“Given the greater level of skill required to successfully navigate a hedge fund strategy and the risks involved, investors are having difficulty navigating hedge funds. In particular, they are struggling to determine whether a particular hedge fund manager has skills, as well as how to construct portfolios using hedge funds.”