Hedge funds offer downside protection and reduced volatility

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The change paves the way for South Africa to abandon its existing model of unregulated hedge funds and in this way attract large retail interest.

Jacques du Plessis, chief investment officer at AlphaWealth, believes that hedge funds will transition from the exclusive investment arena of a select few to an attractive investment option for the broader investment community.

The shift occurs against a backdrop of a well-established hedge fund industry in South Africa. The first fund started over ten years ago and the industry now stewards in excess of R53bn. "Local hedge fund managers have thrived and produced world-beating risk adjusted returns, but the majority of inflows come from a select group of pension funds and high net worth individuals," says Du Plessis.

Comparative returns

The HedgeNews Africa Long/Short Equity Index produced a return of +14.03% in 2014, outperforming the All Share (+10.88%), average South African Equity General Unit Trust (+10.4%) and the All Bond Composite Index (ALBI) (+ 10.15%).

Two classes of funds will be distinguished in South Africa, namely:
• retail hedge funds available to the public, which will be allowed to solicit investments from all investors as do unit trusts; and
• qualified hedge funds, which are only available to investors who meet certain qualifying criteria.

Given their retail focus, the highest investor protection has been applied to retail hedge funds. Qualified hedge funds are less restrictive, but there are a number of requirements.

"With the JSE ALSI at a precarious level and many pundits believing that a pull back is long overdue, the opportunity for hedge funds to showcase some of their famed downside protection and reduced volatility might be just around the corner," predicts Du Plessis.

Flagship fund

AlphaWealth has been involved in the hedge fund space for almost 18 years and has funds with ten year track records. Its flagship hedge fund of funds, Alpha Equity Hedge, was recently ranked first over 12 months from a risk adjusted perspective in the Alexander Forbes hedge funds survey. This fund has seen R50m in inflows over the last three months.

This fund aims to participate in two thirds of the market upside and limit the downside to a third. It has a more than seven year track record and has achieved 12.4% annualised return since inception versus the JSE All Share of 11.7%. These higher returns were achieved while taking on only one third of the volatility.

Du Plessis says that South Africa is not the first market to undergo this type of regulatory change. "The European equivalent Undertaking for Collective Investment in Transferable Securities (UCITS) was originally designed to provide a set of European Union directives aimed at creating funds that could be marketed freely across the region, but it provided the opportunity for many hedge funds to convert into a retail collective investment scheme.

Risk adjusted returns

"Credit Suisse studied the hedge funds that made use of these changes and found no significant decrease in performance when compared to a manager's original offshore fund. In general, there was lower volatility and therefore better risk adjusted returns," says Du Plessis.

The Alternative UCITS market has experienced tremendous growth with assets under management increasing by over 40% in 2014 to $225bn. There were 53 new alternative funds launched in 2014 despite the very modest returns produced. "This reflects the healthy interest from investors and managers to make use of the UCITS structure, which bodes well for the local hedge fund industry," says Du Plessis.