In 2011, changes were made to Regulation 28, the legislation that dictates the limits for the types of investments that may be used in managing retirement fund money. One of these changes was that hedge funds and private equity funds would expressly be recognised as asset classes and their combined limits increased to 15%, with a maximum exposure to either of these asset classes of 10%.
Recently, the chairman of the hedge fund standing committee at the Association for Savings and Investment South Africa, commented that "...the majority of the new cash coming into the hedge fund industry is from local institutions such as pension funds; those funds that were not invested in hedge funds prior to the changes to Regulation 28 and now have the opportunity to include these funds in their portfolios." He further commented that "...there is a definite shift in momentum with a lot more interest from trustees and investment advisers. Therefore, we are expecting a steady increase in hedge fund investment from the institutions."
Nathan, however, believes that such a shift could be value destructive for most retirement investors. "In general, complex products serve the industry far better than the investor. Alternative products, such as hedge funds are very expensive, often having 2% per annum management fees and as well as complex performance fee structures - sometimes as much as 20% of gains - which can erode substantial long term wealth."
Nathan points to a recent study by Grant Thornton in the UK, which concludes that performance fees have had little effect on manager performance over the period 2003 - 2007, and that their main effect appears to have been to increase financial returns to asset managers. The complexity of these products further creates the need for advice, which adds another layer of fees. "There is also a huge variation in the returns produced by alternative funds. Some have done well and others not, so it's not just a case of allocating a percentage of your fund to alternatives."
According to the Novare Investments South African Hedge Fund Survey 2012, fixed interest hedge funds delivered 18% for the year, but manager returns ranged from 2.2% (worst) to 44.9%. There was a huge spread of results in the equity market neutral funds which delivered between -11.8% (worst) and 24.1% with an average 4.9%. The equity long/short strategy - which remains a popular hedge fund strategy attracting some 44.9% of total industry assets - achieved 16.1%.
"Low correlation of alternatives is often due to not marking these investments to market (i.e. not valuing at market value) when markets fall, as many alternatives are leveraged bets on underlying investments like equities and can increase your risk (correlation) not decrease it," says Nathan. "The fact that the several alternative funds don't revalue their portfolios frequently conceals this."
Nathan says the amount of expertise, time and effort involved in trying to understanding where your money is actually invested and the risks taken is well beyond most pension fund trustees, who should never invest fund member assets in instruments they don't fully understand.
"Besides not generating superior long term risk adjusted returns net of fees, alternatives can only account for 15% of a pension fund portfolio, so trustees should focus on the 85% to 100% of the portfolio that is often subject to poor long term returns due to investors making poor investment choices, active manager under-performance and high fees."
"Retirement investors are not obliged to address transformation, regional development, banks' structural funding mismatch or any other inefficiency in capital markets. These issues may well benefit from sound retirement investing, but they cannot be the objective," concludes Nathan.
