Picture: 123RF/kchung
Picture: 123RF/kchung

It is clear we still have some way to go to dispel some persistent myths around hedge funds. Last week, Steven Nathan, the CEO of prominent investment management firm 10X, which specialises in low-cost, passive investment products, made a number of misleading comments about the SA hedge fund industry.

In the FM (February 21-27), Nathan is quoted as saying that "transparency of reporting … is seldom available", that the reported numbers "greatly overstate the returns achieved" and that "performance data for hedge funds is highly unreliable". This is all factually incorrect.

Myth #1 — Hedge funds always charge high fees

Typically, hedge funds charge a 1% basic management fee and 20% performance fee (if a cash hurdle is exceeded). Many funds offer institutional investors a zero percent basic fee with a higher performance participation rate (typically 25%) — similar to the Warren Buffett partnerships of the 1960s. Almost all hedge funds also follow the high-watermark principle, ensuring that the performance fee is never charged just for making up previously lost ground. A well-designed performance structure ensures a high fee can only be charged when high performance is delivered. What ultimately matters most is what returns investors get, after fees are deducted.

Myth #2 — Hedge funds deliver disappointing performance

If you take a large-enough sample of any group of fund managers, there is almost a guaranteed probability that they would underperform a broad market index over an extended period. This is not a contentious statement, but it is often misconstrued as meaning that "all funds" will underperform a broad market index over the long term, rather than "the average fund".

At the same time, a small number of fund managers will outperform a broad market index over the long term. To be sure, the hedge fund industry is extremely competitive — so it is very difficult to outperform and any outperformance is lumpy, as a manager can’t outperform every year.

But investors can access monthly disclosure documents on the hedge fund websites. There, they’ll be pleasantly surprised to see for themselves how hedge funds have fared over the long term, after fees.

Myth #3 — Hedge funds are opaque

Hedge funds are regulated in terms of the Collective Investment Schemes Control Act, which requires full disclosure of costs. Performance is always reported after fees, and proper risk management is a requirement.

The public can invest directly in a Retail Hedge Fund (with a R50,000 minimum) or in a Qualified Investor Hedge Fund (R1m minimum).

Perhaps some of the misunderstanding about hedge funds has been caused by the lack of easily available performance data. But this is due to the Association for Savings & Investment SA hedge fund classification framework not yet being finalised. Thankfully, this is expected midyear.

As the industry, we also hope that the National Treasury and the regulator, the FSCA, will soon address the anomaly in terms of which pension funds can invest up to 10% directly into hedge funds (according to regulation 28) but traditional unit trusts are prohibited from investing in hedge funds.

The release of last week’s Hedge Fund Special Report in the FM also coincided with the hedge fund industry’s 10th annual awards, hosted by HedgeNews Africa, which had 68 nominations for various risk-adjusted performance awards over 1, 3, 5 and 10 years. The winning fund in each of these periods outperformed the FTSE/JSE all share index, with the Fund of the Year returning over 24% for 2018 (net of fees) and the top fund over 10 years returning more than 20% per year (net of fees).

So, many hedge funds are outperforming investors’ expectations. The detractors who say "It cannot be done!" shouldn’t be interrupting those who are doing it.

*Verster is a hedge fund manager