STEPHEN CRANSTON: There are still opportunities in hedge funds for local investors

The hedge fund sector has not been much of a commercial success in SA. The first batch of respectable hedge funds were launched in about 1998. Yet in the intervening 27 years, the industry has gathered a negligible R100bn or so — about the same as the Coronation Balanced Plus unit trust alone.

One of the good things for investors is that, unlike many jurisdictions, investors can still invest in the top-performing hedge funds. They have not had to close to new business because they are too large and lumbering, which would turn them into closet index trackers, particularly on the small and shrinking JSE.

One of the high points of the hedge fund year is certainly the Peregrine Capital annual letter. Unlike its main competitors in the sectors such as 36One, Fairtree and Laurium, Peregrine has remained a dedicated hedge fund manager — with the exception of a small “long only” (traditional) global equity fund.

Peregrine has an impressive long-term track record and has gathered close to R30bn in its two funds, the High Growth fund — which it compares to high-equity balanced funds — and the Pure Hedge fund, which has a risk profile more in line with low-equity funds.

The Pure Hedge fund has given an annualised 12.5% return over 15 years, compared with 8.1% for the low-equity balanced sector — and the extra returns look even more impressive than this compounded over that time. The more aggressive High Growth fund has done even better, with a 17.2% return over 15 years, compared with 8.9% for the high-equity balanced cohort.

In some years the funds really shoot the lights out with a single idea. Recently, it was a big buyer of Thungela Resources, the thermal coal businesses Anglo American rather foolishly unbundled a few years ago to prove its environmental, social and governance (ESG) credentials.

Its share price grew significantly from its listing price, even though some of the more woke fund managers avoided it. In other years its performance was driven by a series of small factors, according to Peregrine Capital executive chair Dave Fraser, who has been a portfolio manager at the firm since inception.

The firm was started by Fraser, Clive Nates and Sean Melnick in 1998. They had all been trained at Liberty Asset Management, the leading SA fund manager of the 1980s and 1990s. It had an old-school “kick the tyres” approach to company analysis, which is now the Peregrine Capital hallmark.

If Peregrine doesn’t like a share, it doesn’t own it, and it doesn’t worry about the benchmark weighting. It holds no platinum shares right now, for example. Fraser says despite the grand title of executive chair he doesn’t just turn up at the office for a couple of hours and go home for a nap. He is a full-time fund manager, along with CEO/chief investment officer Jacques Conradie and executive director Justin Cousins.

One improbable recent success has been Steinhoff preference shares. Fraser says Peregrine bought its first Steinhoff preference shares at below R20 per share and continued to buy them in the market all the way from 2017 to 2023. He says, perhaps understandably, many other fund managers wouldn’t touch any securities with the name Steinhoff on them. But the pref share has proved to be a good investment, recently trading around R100.

Fraser says the detailed analysis indicated that the SA Steinhoff entity had no solvency or liquidity issues, and this ultimately proved correct. It was not affected by the poor international acquisitions Markus Jooste made at the top company, Steinhoff International.

The value of the preference share was covered multiple times by the Pepkor shares owned by that entity, and Steinhoff continued to pay contractual dividends on the preference shares during the entire restructuring process because the SA entity was solvent and healthy, Fraser points out.

Peregrine also squeezed more juice from the Fortress property lemon. In 2023 the Fortress A and B share structure had been collapsed and wasn’t universally popular as it provided limited dividends to some shareholders. But Fraser says Fortress still has two distinct and unrelated businesses — a significant investment in JSE-listed Nepi Rockcastle, and the Fortress-managed SA logistics and retail properties.

Nepi Rockcastle delivered a capital return of 9% in 2024 in rand, even though its income is derived entirely overseas. In comparison, the SA properties, as measured by the Fortress return excluding their Nepi Rockcastle ownership, delivered a capital return of 136% for shareholders.

“As a hedge fund, our funds could construct a position that gave us direct exposure to the SA property portfolio — the component of Fortress that was most undervalued at that time.” Fraser points out that this capability is simply not available to long-only managers given their more limited toolset.

Peregrine’s approach could be called the opposite of black box. Fraser says its constructive engagement with Fortress did not stop once the A and B shares were collapsed into one. The main focus for the year was to engage with the board and other shareholders to restructure executive pay, aligning the interests of the executive with shareholders and rewarding value created at a per share level.

In fact, according to Fraser, there is still a significant opportunity for Fortress to lead the property sector in maximising per-share returns for shareholders through rational and disciplined capital allocation. “The Fortress team has done well over the past four years, but they can do even better,” he says.

• Cranston is a former associate editor of the Financial Mail.