The bulls have trampled the hedges
Poor performance amid bull markets has battered hedge funds, but their fortunes could soon change
Hedge funds have had a challenging few years. Locally, the 12 months to June 2017 brought with it the industry’s first decline in assets in five years, according to the Novare hedge fund survey.
The survey, in which 54 hedge fund managers collectively managing more than 98 uniquely mandated funds participated, found that assets under management among single managers decreased 9.1% to R62.4bn, remaining just a fraction of the R2 trillion unit trust industry.
Financial Services Board (FSB) figures reveal that at December 2017, there were 295 registered hedge fund portfolios, including funds of hedge funds, with
R88.6bn in assets.
“The main contributing factors to the decline include in-house consolidations of product offerings by asset managers and outflows due to meagre performance in the period under review,” says Eugene Visagie, head of hedge fund investments at Novare.
Local hedge funds are not alone in experiencing trying times. The US$3.2 trillion global hedge fund industry has struggled to outperform long-only active managers and index funds amid sustained bull markets.
In 2017, the S&P 500 returned 18.74%, while London’s FTSE 100 climbed 7.65%, ending the year at a record high. Japan’s Nikkei rose 19%, the Nasdaq 100 jumped 32% and Germany’s DAX increased nearly 13%. The JSE’S all share index ended the year nearly 18% ahead of where it started.
A number of years of poor performance has forced formerly successful global hedge funds to close and return funds to investors. Underperformance has also intensified criticism of hedge fund fees.
“In big bull markets, hedge funds don’t do well,” says Murray Winckler, co-founder and portfolio manager at Laurium Capital, which manages three hedge funds with R3.3bn in assets. “When markets are going up modestly and are volatile, hedge funds do well.”
Chris Harmse, senior investment analyst at Asymmetry Asset Management, says the top-performing hedge funds ended 2008 between 30% and 40% higher, while the S&P 500 was down almost 40%. In a holistic financial plan, hedge funds are there to offer downside protection, says Harmse.
Asymmetry’s R35m-in-assets hedge fund takes positions in asymmetric risk/return profiles across the globe. For instance, its long position in Trellidor, a company that would suffer from a rise in aluminium prices, is offset by a long position in Hulamin, which would benefit from an increase in prices.
Hedge funds aim to reduce risk while delivering overall positive returns. At the same time, hedge funds also use leverage (debt) in their portfolios, which can magnify losses if not properly managed.
For this reason, hedge fund managers need to have a good grasp of risk and robust risk management processes, says Jean Pierre Verster, portfolio manager at Fairtree Capital, which manages hedge fund assets of R5bn.
Characteristics making hedge funds unique include the use of derivatives, short selling and leverage, which should enable them to extract positive performance in upward and downward trending markets, Novare findings show.
“While hedge funds invest in the same asset classes as traditional unit trust funds, they can take advantage of a wide range of investment tools and thereby generate other sources of return. Hedge funds tend to have low correlations to traditional portfolios of stocks and bonds. Therefore, allocating an exposure to hedge funds can be a good diversifier.”
Hedge funds should outperform the index in a full cycle, but it is difficult to sell downside protection in a roaring bull market, simply because “we haven’t had downward
What it means: Hedge funds have under-performed in recent bull markets, but may shine in a new era of volatility