SA investors turning to hedge funds

Fear and uncertainty around the Covid-19 pandemic, Russia's invasion of Ukraine and higher inflation and interest rates globally have led to more South African investors including hedge funds in their portfolios, Old Mutual Multi-Managers says.

Hedge funds, which aim to deliver consistent returns regardless of whether markets are rising or falling, enjoyed an "unprecedented" 30% growth over the past year.

These funds attracted R5.33 billion of South African investors’ money last year, including R4.19 billion from individual or retail investors, statistics released recently by the Association of Savings and Investments South Africa (ASISA) reveal.

Hedge funds have proven their worth as a valuable source of return diversification, Busi Ngqondoyi, Old Mutual Multi-Manager’s head of hedge funds, says.

She explains that many hedge funds have successfully cushioned investors’ capital during market downturns, for example, during the Covid-19 pandemic, and kept pace when the equity market have trended up.

A growing number of individual investors are drawn to this, she says.

South African hedge funds that follow the market neutral strategy have returned on average between 4.5% and 11.5% a year over the past five years to the end of February, according to HedgeNews Africa.

The regulation of hedge funds under the Collective Investment Schemes Control Act (CISCA) since 2015 has helped individual investors feel more comfortable investing in these kinds of funds, Ngqondoyi says.

Miton Optimal, a discretionary fund manager (DFM), says it has taken a while for funds classified since 2015 as retail hedge funds to prove that they can deliver returns on a par with qualified investor hedge funds which have less restrictions.

Retail investors with the required minimum investments - around R50 000 - to invest, can use retail hedge funds that are strictly regulated under the CISCA.

Securities

These funds’ ability to borrow or gear the fund and invest in unlisted securities is limited. They must price the fund daily or monthly and allow investors to withdraw within a month. Investors with more than R1 million to invest and who appreciate the risks involved in investing in hedge funds, can use qualified investor hedge funds.

These funds are also regulated under the act but have no restrictions on gearing or unlisted securities.

Qualified investors may have to wait up to three months to withdraw and the funds can be valued as infrequently as quarterly.

Hedge funds received a boost at the beginning of this year when regulation 28 of the Pension Funds Act was changed to allow retirement funds to invest 10% of their assets in these funds as well as a another 15% in private equity investments, instead of 10% in both.

Hayden Reinders, convenor of the ASISA Hedge Funds Standing Committee, says investment platforms, known as linked investment service providers (Lisps) – have become more willing to offer retail hedge funds that reveal their prices daily, making them more accessible to investors.

If hedge funds are listed on an investment platform it means you can, within the regulation 28 limits, include them as an underlying fund in your retirement annuity or your employer-sponsored fund or umbrella retirement fund if it offers you a choice of investments.

The Financial Sector Conduct Authority this month also proposed amending a board notice detailing the securities and asset classes in which non-hedge fund unit trust funds are allowed to invest. If approved these amendments will allow regulation 28-compliant funds to invest in hedge funds up to the 10% level.

Fund diversification

With hedge funds listing on investment platforms and retirement funds being allowed a greater stake in them, there has been an increase in financial advisors asking DFMs to include them in their model portfolios.

Financial advisors use DFMs to select and combine unit trusts from different asset managers and asset classes to create model portfolios designed to meet different investment needs.

If your advisor uses a DFM, the adviser will help you determine your investment need and match that to the DFM’s appropriate portfolio.

Miton Optimal's executive director for its DFM, George Dell, and portfolio manager Jacques de Kock, say advisors are asking for hedge funds to be included in their model portfolios to further diversify the exposure to funds that invest long-only (do not short the market) and index-tracking funds.

They believe market neutral hedge funds can help manage sequence risk in an investment-linked living annuity used for income in retirement.

Sequence risk is the risk that comes with the order and timing of your investment returns which is very important when you are near retirement or drawing an income.

The relatively high rate at which many retirees are drawing from their living annuities and the underlying investments they require heightens the volatility and the risks, Dell and De Kock say.

Options

Miton Optimal launched two pure hedge fund model portfolios, specifically to be blended into living annuities and non-regulation 28 investments.

Old Mutual Multi-Managers has also responded to the increased demand for hedge funds from individual investors by making its Long/Short Equity Fund available to them as well as institutional investors.

The fund selects and blends different hedge fund managers into a single fund.

High costs on hedge funds can be off-putting for investors, but Ngqondoyi says hedge funds fees have come down significantly and the base fee is now half what it used to be.

Dell and De Kock say costs are high - the total expense ratio on its hedge fund model portfolio that targets CPI plus 6% is 4.5% but after fees the performance and lower volatility are worth it.

Hedge funds typically charge a base fee and a performance fee on any returns earned above a stated performance hurdle.-Fin24