Hedge funds – Playing a waiting game.

The changes to regulation 28 of the Pension Funds Act could not come too soon for hedge funds. When they are implemented on January 1, pension funds will be able to invest 10% of their assets in hedge funds. This should boost the size of the SA hedge fund industry considerably .According to the authoritative Novare hedge fund survey, hedge fund assets on June 30 were R31,4bn. This is less than 1% of aggregate pension fund assets and down from R32,1bn in 2010. And considering that about a third of assets are owned by private clients or the hedge fund managers themselves, the exposure is more like 0,7% of pension fund assets.Carla de Waal, a portfolio manager at Novare’s fund of hedge funds business, says that though there were inflows of R8bn into hedge funds in the 12 months to June, the outflows were R7,7bn.“Little new capital was allocated to the industry, and most capital movement took place between managers,” she says.Fund managers still have ambitions to set up hedge funds and a further 15 funds were created during the year. The new funds were not very original. The majority were market-neutral funds. These are classic hedge funds, as developed by AW Jones in New York in 1949. These funds take a long position (a shareholding) in a company and offset it by selling short a share in a company in the same industry — in the SA context, long AngloPlat and short Implats, or long Truworths and short Foschini. The aim is to neutralise the exposure to the overall market (known in investment jargon as beta) and get the full benefit from superior share selection (or alpha).Most of the rest of the new funds were long/short equity funds with a variable bias. These are managed much like market-neutral funds, except that they will try to capture market beta when appropriate. According to the Symmetry survey, long/short funds have provided an average return of 9,5%/ year over the past three years. This varies between 19 % for the Coronation Presidio Fund to minus 5,2% for the unfortunately named Cogito Alpha Fund.
Other money-losing funds have been disbanded, so investors need to be aware of what is called the survivorship bias in these surveys.

There is also a factor called backfill: fund managers submit hedge funds to surveys only if they have had a respectable track record; there are plenty of bad funds that are not captured.

Market-neutral funds tend to give more homogeneous returns as they should have cut out market volatility. But over three years there has been a wide range of returns, from 13,9% for the X-Chequer Market Neutral Fund to 2 % for Investec Active Quants Fund — an indication that with hedge funds it is not enough to buy the famous brands.

A boutique hedge fund operation can be profitable on much lower assets under management than a long-only fund; long-only houses aim to manage at least R10bn to be profitable on a sustainable basis, while hedge fund managers can make a living with assets as low as R800m.

But during the year a number of funds, with combined assets of R3bn, were disbanded : 84% of this figure related to funds with R200m or less, which seemed likely to remain subscale as long as the hedge fund industry was not growing.

It is hard for a hedge fund to make a living even if it does produce real returns. De Waal says the annual fee on hedge funds is 1%, half the 2% average worldwide. But the funds also earn a 20% performance fee on every rand earned above benchmark. The benchmark in hedge funds is always an absolute benchmark such as cash or inflation, and never a relative benchmark such as the all share index .

It is still a young industry. Funds with a track record of 10 years or more manage just 7,3% of assets. Even seasoned fund houses close funds — recently Old Mutual Macro Stable and PSG Double Diamond were closed.

There has been growth in the fixed income hedge fund category, with a 19,3% share of the industry total, but equity long/short remains top with 37,7% of assets. One fixed income fund, Brait Matrix, has more than R1bn under management. In some cases the fixed income funds gave a performance that put their equity counterparts to shame. Over the 12 months to August, AcuityOne Hedge Fund gave a 25,1% return, and Matrix 23,8%.

De Waal argues that hedge fund investors are well rewarded on a risk/ reward basis. She notes that SA hedge funds have a high level of self-regulation, as most use third-party administrators and established prime brokers.

But pension fund trustees will need to know more about the products before they are comfortable investing in hedge funds.

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