Still place for hedge funds
There has been much negative press surrounding South African hedge funds this year. A key, overlooked aspect, is that despite a sharp 5.05% sell off in the FSTE JSE All Share Index (Alsi) in September, a number of hedge funds have provided significant downside protection, reduced volatility and are positive year to date.
From 1900 to end 2016, the SA market was the world’s best-performing market, delivering an average annual return of inflation plus 7.2% according to the 2017 edition of the Credit Suisse Global Investment Returns Yearbook. This yearbook compared the returns of asset classes over 117 years in 21 countries with a continuous investment history. This ongoing upward trend has made many SA investors complacent.
After a positive return in August for SA equities, September saw the market sell off sharply, giving back August gains and extending the year-to-date loss to 6.38%. SA investors began to question the status quo after three years of sideways movement. This saw big shifts in asset allocations from aggressive and multi-asset funds to income-producing, cash-like products.
But one could argue that the timing of retail investors is wrong considering the value offered by SA equities currently. History suggests buying stocks at these low levels has yielded positive long-term returns. The SA small and mid-cap sector, for instance, has not just moved sideways but has had big losses over the past few years so this segment appears deeply discounted. While the rest of the world has been getting more expensive, small and mid-cap SA stocks were getting cheaper.
Impatience and volatility of returns can be an investor’s worst enemy, causing them to deviate from long-term investment plans that include a large allocation to risk assets like domestic equities. Although the last three years have been tricky for all SA managers, the Alpha Prime Equity Hedge Qualified Investor Hedge Fund has outperformed the market significantly since its 2006 inception and is positive to end September.
This has been done with 60% less volatility, which equates to fewer negative months and smaller losses. The effect is that investors who regularly used hedge funds have been able to allocate a larger portion of assets to growth investments without additional risk, and were more likely to stay invested due to lower volatility.
Instead of moving away entirely from risk/growth assets to cash-like products, a more prudent option would be to include some quality hedge funds that can still capture the upside in a very discounted market, while protecting against sharp drawdowns. The key is to understand what you’re buying.
John Haslett is an AlphaWealth portfolio manager