Hedge funds – they say it’s all in the name

Invariably, the mention of hedge funds invokes a range of responses amongst institutional investors. Most of us struggle to grasp exactly what a hedge fund is, and even fewer can articulate its value.

Moreover, the apparent absence of a universally agreed and standard definition presents an almost superficial barrier to investing in these strategies, particularly for institutional investors. Fiduciaries may wonder how they can trust something that can’t even seem to define itself. Bonolo Zwane, Managing Director of Sanlam’s Hedge Fund of Funds platform, Blue Ink Investments, unpacks it for us.

Prior to recent regulatory developments, the worst thing about hedge funds was the name itself, “hedge funds”. The high-profile, headline-grabbing scandals that have previously plagued the industry are unfortunately often the first thing that come to mind when you hear the name “hedge funds”. Taking things further, the commonly referenced “hedge funds are an off-benchmark portfolio call” introduces anxieties about returns. Not only that, but you may also be left worrying about reputational risks should things go awry.

The list seems daunting, ultimately leaving trustees and allocators of capital hesitant and mostly confused about the potential value that can be unlocked through investing in hedge funds.

So why bother?

Hedge funds are the next iteration to the evolution of savings

We’ve seen the world of investments continuously evolve in perceived value and form.

The origins of investing can arguably be traced back to the 1700’s where Dutch merchants first began pooling capital, to access a wider and diversified opportunity set to reduce investment risk and grow wealth, thereby attracting an increased number of investors with modest capital.

Since then the benefits of pooled investment vehicles have been applied in various ways to create many flexible investment propositions for the savvy institutional investor. Mutual funds, pension funds and unit trusts all come to mind.

What is consistent is that there have been periods in history when investors were more worried about losing money than they were about making it. Today we find ourselves at a time where both requirements compete for the same attention. Most hedge funds respond well to this through their ability to add value both when risk is rewarded and when it is penalised.

Since National Treasury last year declared hedge fund investments to be collective investment schemes, regulated under CISCA like other unit trust portfolios, it is recognised that hedge funds now have a rightful place within the investment space.

Benefits of hedge funds

1. Growing wealth while limiting losses

Hedge funds are part of Investment 101 – they offer the ability to grow wealth for retirement fund members when risk is rewarded and protect it when risk is penalised.

In order to achieve this, the degrees of investment freedom in the hedge fund manager toolkit are essential – the use of opportunistic as well as responsible borrowing and lending present the potential for solid returns in both upward and downward trending markets.

2. Rightful place in a well-balanced portfolio

Given that hedge funds tend to have positive return potential, lower betas as well as limited correlation to equities, credit and other asset classes such as commodities, their exposure to portfolios places trustees in a relatively good position to compound capital at attractive levels of return over the long term for retirement fund members.

We believe that an appropriate allocation to hedge funds can enhance a portfolio’s return signature in a uniquely different but complementary manner. Even a small allocation can make a positive difference to a well balanced portfolio.

3. Hedge funds in South Africa are now well regulated

The Financial Services Board has pushed for an environment of trust in the hedge fund industry.  This has been achieved through amongst other objectives, monitoring and managing inherent risks as well as enhancing transparency into the investment and operational aspects of hedge funds.

All things considered, the stock markets wait for no man. They will continue to evolve, rewarding those institutional investors who will similarly evolve their mind-sets and investment strategies alongside.

In this case the worst thing about hedge funds is truly only the name itself.