Hedge funds: not exactly an obvious bet
Many hedge funds were anything but in the latest market rout. But that doesn’t mean investors should write them off
Hedge funds like to tout themselves as an alternative asset class with limited correlation to the equity market.
And yet many local funds turned in a woeful performance during March’s market crash.
Seasoned players such as Steyn Capital lost 18.9% of capital, while Capricorn Performer was down 15.9% (see table).
Laurium Capital fund manager Murray Winckler says the largest class of hedge funds in SA — long/short equity funds — will be correlated to the market.
"Broadly they will have a 50% net exposure so you can expect them to rise and fall at half the rate of the JSE. And most funds have recovered in April."
Winckler says market-neutral funds show much less correlation, because ideally they are equally weighted between long and short positions.
The biggest difference between hedge funds and regular funds is that hedge funds can profit from falling markets by short selling. In other words, they borrow shares from a broker and sell them in the hope that they can later repurchase them at a lower price, return them to the broker, and pocket the difference.
But in spite of this additional tool, most hedge funds have been unable to preserve investors’ capital.
Most of the market-neutral funds listed in SA aim to beat inflation plus 3%-4% over time.
But some of these funds probably missold themselves as sleep-at-night funds, with Abax Bao down 5.6% in the first quarter and the Capricorn Stable Retail Fund proving to be not so stable with a drop of 14.6%.
At least All Weather Capital, Old Mutual, Ninety One (previously Investec Asset Management) and Peregrine Capital all got positive returns from their market-neutral funds — though All Weather’s 7.2% return over just three months suggests its strategy might be a little too aggressive for a market-neutral fund.
Winckler says a flat performance in the first quarter would have been good for a long/short fund. Laurium Long Short had a disappointing quarter, down more than 10%, but positive performers included Old Mutual Chronos, up 1.1%, 360ne Retail Fund up 1%, All Weather Capital up 3.2% and Peregrine Capital Dynamic Alpha up 0.5%.
David Bacher, chief investment officer of Corion Capital, a multimanager, says that in the recent market slump it was encouraging that even the worst funds kept losses to less than 20%.
"Especially when you consider that most SA hedge funds have a bias towards mid-and small-cap shares and therefore were more exposed to SA Inc shares than a typical general equity fund," he says.
Interestingly, most SA long/short funds do not have the 30% allocation to offshore assets which is commonplace among general equity funds, and usually have a local-only mandate.
Bacher says some poor performance can be explained by bad stock picking, such as Visio Occasio’s large long exposure to Sasol, which is down about 90% from its 12-month highs.
Fixed-income hedge funds usually provide more homogeneous performance, but Bacher says with the volatility in government bond prices, they have been all over the place.
Top performer Matrix made a 14% return, while Oakhaven, Cadiz and Idwala lost more than 13%.
Gyongyi King, chief investment officer of Alexander Forbes, says funds with a value bias have struggled because many shares continue to trade well below their intrinsic value.
The hedge-funds sector is dominated by boutiques — the biggest player, with a market share of more than 20%, is 360ne, which is a midsized Sandton shop.
But Peregrine Capital, which has now been running hedge funds for more than 20 years, is the manager to beat. Its Pure Hedge Fund has given an annualised return of 20.4% since inception in July 1998.
Peregrine fund manager Jacques Conradie says the team is highly flexible and started to see the full implications of the coronavirus in February when Italy went from three to 200 cases over one weekend. "The US market was close to a record high so we bought put options for half our portfolio and reduced net equity exposure in our long/short funds from close to 70% to 40%. After the correction we have increased it again."
Conradie says he is not convinced that the SA economy can bounce back quickly from the coronavirus, as the government does not have the fiscal firepower for a substantial bailout. A sizeable share of the shop’s equity long positions are now outside SA.
It owns Facebook shares, for example, but for it to remain a domestic fund the holdings are hedged back to rands.
The fund doesn’t usually invest in commodity shares, as they are price-takers with unforecastable revenues, but it has held positions in gold as a hedge against the devaluing of the dollar. It has also bought Sasol dollar bonds, which at one point were trading at 40c to the dollar — and has made a 20% return from these so far.
Peregrine’s most successful trade of the past decade has been Capitec. And it swooped in when the mass-market bank crashed in March. "We don’t typically make money from overnight trades, but we did when Capitec recovered from R550 to R850 in barely a day in March. Normally we make money as patient investors. It look us six years to see the share price go up from R200 to R900."
Cy Jacobs, chief investment officer of 36One, says the shop’s two long/short funds took very little risk in the current market, being about 20% net long in the year to date. And much of that 20% was in US tech names and dollar cash, with a spread of S&P 500 puts for protection. Its shorts included airlines and the US concerts and events business Live Nation Entertainment, all obvious victims of Covid-19.
"But in SA we have run out of shares we want to buy," says Jacobs.
Hedge funds are still a $3-trillion industry globally, yet the SA industry has gathered barely R40bn in assets.
Kim Zietsman, head of business development at Laurium, says the perception of high fees is an obstacle, but "there is a different skill set, which can drive better and more consistent returns, and it is costlier".
She says accessibility is another problem as hedge funds aren’t generally available on the platforms used by independent financial advisers. But the biggest obstacle is that unit trust funds of funds cannot invest even in retail hedge funds.
Protea Capital CEO Jean Pierre Verster says the uptake of hedge funds in the affluent market would have been greater without competition from the tax-favoured section 12J funds.
And he believes there is scope to go well above a 10% allocation for some investors, given that the university endowment funds in the US at Harvard, Yale and Stanford have an exposure of at least 40% to alternatives, including hedge funds and private equity.