Hedge fund returns: Looking past the cost
Hedge funds have rapidly lost favour abroad and at home. But as markets slide, they may be worth another glance
Hedge funds in SA have been losing popularity, rapidly.
But last month’s market rout may finally see these "alternative assets" deliver the returns for which long-suffering investors have been holding out.
The latest figures from Novare Actuaries & Consultants, for 2018, show a fall in total assets under management from R60bn at the start of the year to just R47bn 12 months later.
Instead, investors have ploughed their money into local private equity funds, which now have about R171bn of investors’ cash.
The biggest obstacle for hedge funds is still their perceived high fees. Sygnia abandoned hedge funds in August 2018, calling them "a management-fee racket", while others such as Momentum have downscaled their exposure.
It always looked bizarre to pay up to 4% for a global hedge fund, especially if you consider that in 2019 the average return from hedge funds was just 7% against the US benchmark S&P 500’s gain of 29%. This index can be accessed for a fee of just 0.08% through Vanguard or BlackRock.
But Gwyneth Roberts, editor of HedgeNews Africa, says SA funds have performed better than their international peers.
In 2018, when equities fell 8.5%, the average hedge fund return was a positive 5.2%.
Last year the return was 7.9%, which was better than the capped shareholder weighted index, though short of the 12% gained on the JSE’s all share index itself.
"The problem is that pension funds cannot invest more than 2.5% of their assets in a single hedge fund," says Roberts. "And … regular funds of funds cannot invest in hedge funds, even though their clients can now do so directly."
Jacques Conradie, MD and portfolio manager at Peregrine Capital, says the replicas of local funds offered to foreign clients in dollars have been hit hardest, reflecting sentiment about SA more than any unhappiness about returns.
Investors also remain concerned about the reputation of hedge funds, which are sometimes (wrongly) associated with Ponzi schemers such as the infamous Bernie Madoff or spectacular failures such as Long-Term Capital Management.
But SA funds, under a set of new regulations, are forced to impose basic risk control.
Hedge funds are also due to be sorted into categories, which should make selection far easier: long/short equity, market neutral and fixed income.
The main defining activity of hedge funds is to take short positions in securities. This means borrowing shares from a broker/dealer and selling them in anticipation that they will fall, then exercising the purchase obligation at a lower price. The theory is that hedge funds should be able to make money in any type of market, but especially one that is falling.
As far as the categories go, long/short equity funds might be 70% in long positions and 30% in short; market-neutral funds aim to be close to equal in longs and shorts; and fixed-income funds use instruments such as forward rate agreements to take short positions.
There were certainly plenty of impressive returns from the HedgeNews Africa Awards on February 20.
The top fund of 2019 — Fairtree Assegai, run by Rand Merchant Bank veteran Stephen Brown — achieved 45.4%, driven largely by its heavy exposure to platinum shares.
The top market- neutral fund was the X-Chequer Diplo Hedge Fund, which produced a return of 18%.
The oldest surviving hedge fund in SA, the Peregrine Pure Hedge Fund, has produced an annualised return of 20.6% since inception in 1998 compared with inflation of 5.6%.
And the largest hedge fund house, 36One, continues to produce solid returns — 17.4% last year in its retail hedge fund.
36One’s Cy Jacobs says it helped that the team found shares to short, like Tongaat Hulett, EOH, Nampak and Brait, whose share prices have withered away.
There have been some bad performers, of course: Mazi was down 3.5% in its long/short fund, and its market-neutral fund was down 2.4%. Other losers were the Investec Active Quants Fund (down 4.4%) and Electus (down 1.9%). The Protea SA Retail Hedge Fund was a disappointing performer, returning just 3.8% after an industry-beating 24.3% in 2018.
But, says Protea CEO Jean Pierre Verster: "My process steers me towards higher-quality shares and away from resources. We achieved positive returns in spite of shorting some of the precious metal shares."
Verster says it was not fatal because he spreads his short positions across 40 shares.
Though Investec Quants had a dud year, an entirely different team at Investec set up a long/short hedge fund last year under Hannes van den Berg, an old hedge fund hand from his decade at Fairtree.
The fund aims to leverage off the research done by Investec’s 4Factor process, the shop’s most pragmatic and middle-of-the-road offering, and it returned 13.3% in its first 10 months to December 2019.
Fixed-income funds are often ignored yet they produced some impressive numbers.
None produced negative returns over the past year and the best, such as Terebinth and Southchester, have given 12%-plus every year after fees.
There is survivorship bias in hedge funds — for example, what has happened to the glamorous funds of the past such as Oryx and Mayflower?
It might be quite a short window before the best funds close to new business again.
These investment options should not be dismissed simply on cost.