While global hedge funds had a comparatively poor 2011 they have still outperformed equities over the past decade, says Carla de Waal, head of fund of hedge funds at Novare Investments. "Local hedge funds, on the other hand, performed well on both an absolute and relative basis during 2011, beating equities by a significant margin. The FTSE/JSE All Share Index returned 2.6% versus the median South African single manager hedge fund returning 8.8%."
She says one of the big benefits of hedge funds is capital preservation during extended equity market downturns, with the result that portfolios that include hedge funds also benefit from positive compounding when markets resume their ascent. The historical performance of global funds of hedge funds shows that investors enjoyed a similar return to being invested in global equities over the past 20 years, but with less than half of the risk as measured by the standard deviation.
"Volatility of funds of hedge funds returns has been in line with that of the SA All Bond index, and in some instances even lower. Importantly, local hedge funds managed to preserve capital through the 2008 crisis, and continue to do so amidst market jitters caused by the Eurozone debt crisis," says De Waal. Legislation now allows hedge funds to comprise up to 10% of a pension fund's investments, which should support increased inflows into the local industry.
When constructing fund of hedge funds portfolios, De Waal says she selects managers who don't hesitate to position their portfolios defensively when uncertainties abound. "One of the attributes of the local universe of investable hedge funds is they are amongst the most conservative money managers around. Hedge funds are an attractive proposition because they seek opportunities for profit, irrespective of the direction of the market. "
Hedge funds, as specialised funds that incorporate actively managed strategies, are worth the higher fees they charge. Fund managers are compensated for superior returns by earning a performance fee on top of the basic management fee. "In the majority of cases, we have not found that this contributes to aggressive investment behaviour," says De Waal. "Defensive portfolio positioning and measures like derivative-based hedges to limit downside are evidence of the mindset of capital preservation that is the first important alignment of the manager's interest with that of the investor. "
"Instead of viewing hedge funds as a separate asset class to long only equity and bond investments, different hedge fund strategies can be used alongside long only investments in a total portfolio context to reduce asset class risk, helping the portfolio withstand market storms," says De Waal.
