A hedge fund is a vehicle that houses traditional and alternative investments against equities, bonds and credits.
Cannon Asset Managers’ chief investment officer Adrian Saville says during volatile times investors often rush into hedge funds seeking protection. “But these have proved to be almost as volatile as equity markets with much lower rates of return. The experience of January 2008 comes to mind, when stock markets around the globe traded lower and hedge funds saw losses in that month too,” he says.
Saville cautions against hedge funds. “Hedge funds have a higher beta than people commonly believe and a lower alpha, especially when markets are declining. I would caution investors who believe that hedge funds represent a place of safety for their assets. These funds are also, typically, very expensive.”
Futuregrowth’s head of alternative investment, Grant Watson, says a hedge fund magnifies one’s profits and losses, but doesn’t need to be as risky as is commonly believed. He advises investors to look to market-neutral funds to protect themselves against market sensitivity and protect their returns.
Watson says investors shouldn’t put all their eggs in one basket and should carefully weigh up their risk against their reward. “With a market-neutral fund you have lower risk than investing in gold unit trusts, for example. You wouldn’t want to sink your entire pension fund into it.” Watson says there are a lot of risks in the current market, which is very volatile. Global credit prices are creating uncertainty around commodities.
“If you were two years from retirement I would advise you to put your money into a market-neutral fund, which would reduce your risk of losing capital in the fund.”
South Africa’s hedge-fund market currently sits at about R40-billion and consists of 125 funds.
Watson manages Futuregrowth’s market-neutral hedge fund, which is three times geared but could go up to five times. “Its objective is to outperform the STeFI [short-term fixed interest composite index] by 10% a year. I would be wanting to get 14%.”
Watson says in his experience a market-neutral fund would give investors positive performance irrespective of what is happening in the market. “You should get 12% or 16% every year irrespective of what goes in the market. We started it in 2006 and into 2008 it was the top performing hedge fund in the first quarter.”
Watson says he makes his investment decisions using a multifactor approach. “We look at everything, we look at growth factors, we look at company results and we use a computer to correlate all of these factors before we make a decision.”
He says the investment portfolio must be constructive. “You want it to exhibit the characteristics of whatever you buy. It must have high growth prospects and low financial risk. You also want the momentum coming through in resources.
Market-neutral funds are expected to perform well for the rest of the year, but those that are geared players on the market are in for a bumpy ride, especially in view of the uncertainty around the interest rate.
Watson says anyone from pensioners right down to people who are starting out at work could invest in hedge funds. He says the biggest barrier to hedge funds as an investment option is the lack of understanding. “People have to understand them and what they are trying to achieve. There is a misconception that it is all risk. All it comes down to is knowledge and understanding of what you are looking for and what you need. Market-neutral hedge funds are less risk.”
Cadiz African Harvest Asset Management’s investment strategist and portfolio manager Matt Brentzel agrees, saying alternative strategy funds such as hedge funds are an excellent investment option. “It’s a question of timing. It’s a brilliant alternative when all others have collapsed.’
But Brentzel warns against being in a hedge fund in a bull market. “If you told me five years ago that oil prices would go as they have, I would have moved my money into cash and that would have been the wrong decision. Hedge funds have grown but you don’t want to put all your eggs in one basket.”
He says it might not be a good idea to invest in them aggressively, but says the most important thing is to understand the dynamic that impacts on a hedge fund. “If you have none get some. But don’t put all your money in one basket. Now you had tremendous performance in equity markets, so take some of that profit and put it into a hedge fund. But I have to admit timing is so important and never easy to determine. Sheer luck also comes into play.”
Paul Hansen of Stanlib says hedge funds lower the overall risk of your portfolio. “Your ratio is improved by certain hedge funds. Hedge funds can take refuge against falls in the stock markets and bond markets. They can make money in those areas. But there are a whole array of hedge funds, so you need to be careful which type you invest in.”
He also advises that investors look to the market-neutral funds instead of the more aggressive ones.
Sanlam Investment Management MD Armien Tyer agrees that hedge funds are great investment vehicles if used for the right reasons. “It provides a low to negatively correlated, diversified source of excess return in the cash and bond space. It’s also key that you deal with a credible player as risk management, particularly operational risk, is key.”
Eugene Goosen, head of alternative strategies at Metropolitan Asset Managers, says the current volatile markets have led to a renewed spotlight on absolute return funds (ARFs) in the context of a recent challenging economic environment — both globally and on the local front.
Goosen says in this environment ordinary investors, who are normally more conservative and do not have a high-risk appetite, look for investment vehicles that enable savings but with more capital security than vanilla funds.
“Alternative funds, such as ARFs, are therefore relevant in the current market. An ARF is an investment product that gives reasonable capital security over the long term and is not as risky as a vanilla-based fund.”
In the latest Alexander Forbes Large Manager Watch, Metropolitan’s absolute return fund yielded a return of 14,49% over the past 12 months compared to the average domestic balanced fund, which returned 12,32%.
Goosen says the main reason for this performance is that ARF fund managers have been able to stave off market volatility by employing alternative strategies. This has been very beneficial to investors at a time when the expected return on an asset class such as equities is unattractive.
Looking ahead, MetAM still expects volatility to continue in the local equity market driven by many global factors. “We consequently believe that investors, particularly retirement and others should revisit their portfolios and carefully consider this investment option,” says Goosen.