How SA hedge funds lost their shine
Managers are said to have been caught off guard by the unexpected strength of the rand in 2016 and 2017
The very name "hedge fund" implies that they are a safe haven in choppy markets.
At the very least they are expected to have a different series of returns from traditional equity and bond funds: if not, what role do they serve?
There was a 10% decline in their assets to R62.3bn in the year to June 2017 — the last official statistics. The fall in the year just past could be even more, perhaps to less than R55bn. There has already been one casualty, Kaizen Asset Management, though this was as much because of internal disagreements as from performance. And this is at a time when the other main alternative asset class, private equity, is R170bn-strong and growing.
Sygnia CEO Magda Wierzycka was one of the early adopters of hedge funds, at African Harvest 15 years ago. She is now reducing client exposure to hedge funds substantially.
"They have astronomical fees and they have not delivered on the promise of capital preservation," she says. "In a world of single-digit returns and high volatility, investors are acutely aware of fees relative to performance."
Neil Verster, who runs funds of hedge funds at Novare Investments, says hedge funds have not met client expectations for risk-adjusted returns over the past three years.
It has been an easy decision to liquidate some positions in local hedge funds to increase offshore exposure, which for pension funds has been increased from 25% to 30%.
It is not difficult to see why clients are disillusioned with hedge funds. The high-quality Bateleur Long/Short Fund, which in its early days was producing 40%-plus returns, lost 3.3% in 2016 — though its return of 9.4% for 2017 was well above the sector average.
Tantalum MNC, which has produced double-digit net returns in most of the years it has been around, produced a soggy 1.65% in 2016 and 4.55% in 2017. Even Peregrine High Growth, which has given an annualised return of 26.7% since it was formed 18 years ago, is up just 1.78% over 12 months.
There have been strong performers, however, such as the Laurium Long/Short Fund run by ex-Deutsche whizzkids Murray Winckler and Gavin Vorwerg, which is up 5.4% year to date.
Still, hedge funds have a much larger opportunity to perform better than long-only equity funds.
The main differentiator is the ability to short shares — sell borrowed scrip in anticipation of being able to buy it back later at a lower price.
SA is dominated by long/short equity funds which typically have 20 long holdings and 10 short ones, often taking pair trades in the same sector, for example long TFG and short Truworths.
"There are no excuses in hedge funds," says Obsidian Capital portfolio manager Royce Long. "We can’t hide behind a benchmark and feel happy if we are down only 20% when the market is down 30%."
Long says hedge fund managers were not prepared for the strength of the rand in 2016 and 2017. Life was too easy, going long rand hedges and shorting domestic plays.
Wierzycka says market volatility should help hedge funds to deliver returns, but it doesn’t seem to be the case in SA.
A hedge fund does not need, for example, a chunk of Naspers shares because it is a large part of the index. This, however, has worked to their disadvantage over the past three years when Naspers has accounted for almost all the growth in the JSE all share index (Alsi).
Rowan Williams, manager of the successful Nitrogen Fund, says he combines a fundamental book, in which positions are held on two-year views, with a trading book. The portfolio trades once a month. Yet, in spite of its trading costs, Nitrogen has given a competitive 9.25% a year over five years, while being far less volatile than the Alsi.
Williams says he avoids resources shares as there are so many factors which cannot be predicted, not least the commodity price itself.
"We are at the most active end of the spectrum. I know index funds have their supporters but they are a blunt instrument, a basket of shares with very different drivers."
But Selwyn Pillay, investment manager at Blue Ink fund of hedge funds, argues that long/short funds are too often presented as the flagship product of the industry, and the focus has been on the underperformance from this subset.
But there are also market-neutral funds, which have more consistent returns as they neutralise the market impact or "Beta".
Furthermore, there are commodity and multistrategy funds.
Long-only Africa funds are also considered to be an alternative.
Laurium’s Africa Fund, for example, has $200m under management (R2.6bn) and will be capped at $350m. But the real success story has been the fixed income funds — largely bonds.
Once dismissed as too dull, they have outshone their equity-centric colleagues recently. Over the past 12 months the Cadiz (now Warwick) South Easter has returned 20.1% and Terebinth 27.3%. Even laggard KADD Validus will live to fight another day with a 2.3% return.
Tatenda Chapinduka and Grant Hogan left Blue Ink to set up their own direct manager, Independent Alternatives (IA), close to Rivonia. They saw plenty of hedge fund managers claiming skill, when they were simply riding the bull market.
"A classic case of Beta in Alpha clothing," says Chapinduka. "But it is getting harder to pretend it is all down to skill. The return series could be achieved more cheaply through a mid-cap exchange traded fund, for example."
IA’s ambition is to be recognised as a genuinely multiskilled multistrategy manager, including areas that are underexploited such as soft commodities and foreign exchange.
IA certainly can’t expect success simply on the back of its transformation credentials. Black firms such as Mazi Capital and Sentio have barely R100m each in hedge but north of R15bn in long-only funds.
But some of the pillars of the hedge fund establishment must be in trouble. Steyn Capital (in which Sygnia was an anchor investor) lost 13.5% over a year; Tower Long/Short had a 10.5% fall. It is speculated that both funds took a shine to Steinhoff.
Pieter Davis, a director of hedge investor Edge Capital, says most hedge funds came out of the Steinhoff catastrophe battered and bruised. But they did better on the Resilient collapse, with 36One’s Cy Jacobs being one of the most vocal critics of that group.
These have turned out to be the worst possible circumstances in which to introduce SA’s groundbreaking hedge-fund regulations.
Retail investors can invest from R50,000 in retail investment funds, while qualified investment funds get inflows of R1m or more.
Regulation has brought increased costs but also transparency, with the requirement for monthly performance reporting and total expense ratios. Nosibusiso Ngqondoyi, head of hedge funds at Old Mutual Multimanagers, says retail investors remain largely unfamiliar with hedge funds.
But Hayden Reinders, head of the Association for Savings & Investment SA hedge fund committee, argues that the transition over the past two years into regulated collective investment schemes has gone extremely smoothly.
Ngqondoyi says hedge funds have come into their own in the year to date: in the five months to May, while the market fell 7.3%, the average fund of hedge funds was up 0.4%.
Ngqondoyi says the industry remains fragmented: 22 funds have less than R50m under management; some of these were launched in anticipation of pent-up public demand.
But as much as last year might have been tough, this year things are looking up.