The top three reasons for investing in hedge funds are typically diversification, composite portfolio strategy enhancement and decreased volatility. However, these all proved challenging for global hedge funds when the financial crisis hit.
Globally, hedge funds lost value right along with other asset classes. But not in South Africa.
Unlike some global hedge funds, South African managers take a more thoughtful approach to investing, aiming by and large to capture a little bit less of the upside performance of the market, but protecting much more on the market downside. How have they fared?
The Table below shows a range of descriptive statistics over the six year period since January 2007 for various market indices compared to the HNA SA Fund of Funds Composite and the HNA SA Single-Manager Composite indices:
What the table shows is that in fact, South African hedge funds fared very well. Over the last six years, South African hedge funds overall have performed as well as the various market indices, but at a much lower volatility and risk profile than the market.
Looking at the percentage of positive return months compared to negative return months over the period, hedge funds dramatically outperformed equities. The Fund of Funds composite index produced positive returns 83% of the time and negative returns 17% of the time, while the Single-Manager composite index produced positive returns 97% of the time, and negative returns only 3% of the time.
The significance of using hedge fund strategies in a portfolio is highlighted by focusing on two important periods, namely the crash or bear period, from March 2008 to February 2009 and the subsequent recovery since March 2009.
During the crash over the 12-month period from March 2008 to February 2009, the ALSI lost a staggering 37.59%, while the Fund of Funds composite index produced a positive return of 1.19%, and the Single-Manager composite index returned a satisfying 9.26%, providing capital protection when investors needed it most.
The case for including hedge funds to your asset allocation mix to complement your composite portfolio is clear, looking at Table 3 below. This shows the return performance since the beginning of the bear period, March 2008 until end of December 2012.
The table shows that while the equity market indices bull run since March 2009 has been impressive, it had to claw back lost performance during the preceding bear period first. Since the start of the bear period (February 2008) untill the end of December 2012, all these indices (both market and hedge funds indices) have produced similar performances, but at varying degrees of risk and volatility levels.
The South African hedge fund investor experience over the past six years should be clear. During a bull period, the equity market should, and did, outperform the hedge fund indices; but during a bear period, the hedge fund indices protected investors from the significant capital loss experienced by equity market indices.
The trick to investing in hedge funds is to approach them not as a separate asset class, but to think of hedge funds as an enhanced strategy that you should take in addition to your equity and bond investments.
Head of RisCura Analytics
For more information, please contact Albrecht Gantz via email or on +27 (0) 21 673 6999. Please visit HedgeNews Africa for the latest performance data. This article first appeared in the August 2013 issue of FAnews.