Victus Group

An introduction to hedge funds

Jun 2021

At the end of 2020 there were 120 active hedge funds in South Africa with combined assets under management totalling R73.27 billion.

Statistics released by the Association for Savings and Investment South Africa (ASISA) show that assets under management increased by R4.35 billion in 2020 from the R68.92 billion managed by local hedge funds at the end of 2019.

Hedge funds can be seen as instruments that provide absolute returns while protecting the invested capital and are able to benefit from both falling and rising markets. ASISA says that hedge funds should not be seen as a higher risk alternative to, for example, unit trust funds, but that they should rather be viewed as one of the building blocks of a well-diversified investment portfolio.

Hedge funds have traditionally been intended for use by sophisticated investors such as institutions or high-net-worth individuals. Hedge funds are designed to mitigate the impact of market volatility on capital by applying specialist strategies within the different asset classes.

Contrary to popular belief, South African registered hedge funds are relatively conservative when compared to their global counterparts and they generally seek to provide steady returns for investors. Compared to traditional asset classes, hedge funds typically demonstrate shorter recovery periods that are also smaller in size when markets correct.

Investment strategies

Some of the more well-known strategies used by hedge funds in South Africa include:

  • Equity long/short – Buying some stocks and shorting others.
  • Equity market neutral – Again employing both long and short positions, such that the fund is not exposed to market direction.
  • Fixed income arbitrage – Taking advantage of inefficient pricing in the fixed-interest markets.
  • Multi-strategy – Using a variety of underlying hedge fund strategies.
  • Volatility arbitrage – Taking advantage of the difference between implied volatility and realised volatility.

Regulatory environment

Hedge fund managers are governed by the regulations of the Financial Sector Conduct Authority (“FSCA“), as is any other Collective Investment Scheme. South Africa became the first country in the world to put in place comprehensive regulation for hedge fund products in 2015 when hedge funds were officially regulated and declared as collective investment schemes in terms of Section 63 of the Collective Investment Schemes Control Act 45 of 2002 (CISCA). The regulations provide for two categories of hedge funds, namely Qualified Investor Hedge Funds and Retail Hedge Funds.

ASISA explains that Qualified Investor Hedge Funds require a minimum investment of R1 million and are open to investors with a solid understanding of the investment strategies deployed by hedge funds and the associated risks. Retail Hedge Funds, on the other hand, are more strictly regulated in terms of the investments and the risks that they are allowed to take and are open to all investors who can afford the average minimum lump sum investment amount of R50 000.

Classification

Hedge funds in South Africa are classified according to their investment strategies:

  • Long Short Equity Hedge Funds are portfolios that predominantly generate their returns from positions in the equity market regardless of the specific strategy employed such as “long bias” and “market neutral”.
  • Fixed Income Hedge Funds are portfolios that invest in instruments and derivatives that are sensitive to movements in the interest rate market.
  • Multi-Strategy Hedge Funds are portfolios that over time do not rely on a single asset class to generate investment opportunities but rather blend a variety of different strategies and asset classes with no single asset class dominating over time.
  • Other Hedge Funds are portfolios that apply strategies that do not fit into any of the other classification groupings.

Choosing a fund

Because hedge funds are actively managed funds where the fund managers are responsible for the performance of the funds through the investment decisions they make and the strategies they choose to employ, hedge funds are exposed to both market and management risk. Consequently, choosing the correct hedge fund to invest in has much to do with choosing the correct hedge fund manager. Although this choice will obviously be influenced by the manager’s past performance, investors also need to be aware of the strategies they employ, to predict the probability of future success.

Hedge funds are one investment area where picking a winner is an essential ingredient for success; investors should therefore take care and do their homework before deciding on a fund manager to entrust their hard-earned money to. Investors are best advised to contact their financial adviser prior to making any important investment decisions, such as choosing to invest in a hedge fund.

The information contained in this article is of a general nature and intended for information purposes only. It is neither to be construed as financial advice nor to be regarded as a definitive analysis of any financial, legal or other issue. Individuals must not rely on this information to make a financial or investment decision. Before making any decision, we recommend you consult your financial planner/adviser to take into account your particular investment objectives, financial situation and individual needs.