Alternative Investment

In turbulent times like these, hedge fund investing makes sense

These are scary times for equities as markets trend lower, caught in a vice grip of rising interest rates, inflation and war in Ukraine.

In periods like this, hedge fund investing – with its promise of capital protection and reduced risk – starts to look particularly attractive.

Hedge funds have grown in popularity over the last decade, due to their ability to take more aggressive positions (including shorting the market) and invest in a wider universe of financial products than unit trusts. Many hedge funds are structured to beat inflation by a predetermined margin, one example being the Laurium Market Neutral Fund, which invests predominantly in SA equities and aims to beat consumer inflation by 5% a year, over any three-year rolling period.

The fund’s percentage growth performance (the red line) is illustrated in the graph below, measured against the JSE All Share Index, consumer inflation and short-term fixed income funds (STeFI). What’s striking about the graph is that it has delivered growth similar to the JSE All Share Index – but at much lower risk.

Source: Laurium Capital

The hedge fund industry was launched in the early 1990s and has grown into a $5 trillion (more than R90 trillion) global phenomenon, with a variety of investment styles including long-short equity, market neutral and volatility arbitrage, to name a few. Funds frequently use derivatives and leverage in an effort to mitigate downside risk and in some cases, amplify returns.

Value of assets managed by hedge funds worldwide, 1997-2022

Source: Statista 2022

While interest in hedge funds and alternative investments has exploded internationally, South Africa lags behind. The largest endowment funds globally have 20% to 50% exposure to hedge funds and alternative investments, compared with less than 10% in SA.

Kim Zietsman, head of business development and marketing at Laurium Capital, believes the figure in SA should be closer to 15% to 20%.

However, there are signs of a shift in sentiment.

“We’re getting quite a few inquiries from financial advisors looking to allocate to hedge funds,” says Zietsman. “There’s also strong interest from discretionary fund managers, responding to the pressure they are getting from their clients, who are financial advisors.”

“Their primary interest is how they can get equity-like returns with lower risk for their clients.”

How much can be allocated to hedge funds in South Africa?

Zietsman says in terms of Regulation 28 of the Pension Funds Act – which defines limits on exposure to different asset classes within retirement funds – it allowed for an aggregate 10% allocation to hedge funds, with not more than 2.5% exposure to any single fund. Adjustments to Regulation 28 introduced in July 2022, now see this 10% allowance for hedge funds exclusively, whereas previously this 10% ‘budget’ was shared with other alternative asset classes too.

“This exclusive space is an important improvement on the previous limits imposed by Regulation 28,” says Zietsman. “But that limit can be much higher for discretionary funds falling outside the purview of Regulation 28, such as endowments, living annuity funds and non-retirement savings.”

The Collective Investment Schemes Act prevents unit trusts from investing in hedge funds – something the industry is lobbying to change.

“It doesn’t make sense to deny unit trust fund managers the ability to better protect and grow the savings of investors by shutting them out of hedge funds, so we definitely want to see this changed,” says Zietsman.

What are some of the key challenges facing hedge funds in SA?

“We’d like to see some changes to the regulatory environment to allow unit trusts to invest in hedge funds,” says Zietsman. “Another barrier we face is that boards of trustees lack knowledge of the industry. We need to do more education around this: explain the benefits, risks and uses of hedge funds.”

“SA is quite heavily regulated compared to other jurisdictions. We have to submit monthly reports to the Financial Sector Conduct Authority (FSCA), and that is a good thing.”

“Fund managers in SA are quite conservative, and the fees are often high, but what the industry should be measured on is returns after fees.”

Who should be investing in hedge funds?

Historically, hedge fund investment was targeted at high-net-worth individuals, fund managers and financial advisors, but barriers to entry have fallen in recent years, opening this potential investment avenue up to a far wider market.

The retail market now has access to a wide range of hedge fund investment strategies. For most, access to hedge funds is through their financial advisors.

The proliferation of investment platforms offered by the likes of Allan Gray, Glacier, Ninety One, Momentum, INN8 and others have made it easier for financial advisors to participate in hedge funds.

How have SA hedge funds performed in the 2022 inflation crisis?

The chart below shows how Laurium funds performed relative to the JSE All Share Index and the hedge fund average for SA.

Source: Laurium Capital

The Laurium funds delivered positive returns of between 9.5% and 16.5% for the year to 31 August 2022, against -6.2% for the JSE All Share Index and 2.2% and 5.2% for the SA hedge fund industry as a whole.

“For those looking to protect capital and beat inflation in this turbulent environment, there is an undeniable case for increasing exposure to hedge funds,” says Zietsman.

Brought to you by Laurium Capital.

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