Investment

Local hedge funds outperform other asset classes in first half of 2010

While the perception amongst many investors is that hedge funds have been amongst those funds hardest hit by the recent market volatility, the performance of this asset class tells another story completely.

According to the Blue Ink All South African Hedge Fund Index, which tracks the performance of around 100 hedge funds in South Africa, the average fund increased by 7,58% net of fees for the six months to 30 June 2009. This is significantly higher than the 4,1% rise in the JSE All Share Index (ALSI) and the -4,85% of the All Bond Index (ALBI).

Measurement period

Returns to 30 June 2009

JSE All Share Index

All Bond Index

STEFI (Cash)

Blue Ink All SA Hedge Fund Index (net of fees)

3 Year (annualised)

4,24%

7,59%

10,07%

12,25%

1 Year

-24,89%

19,27%

11,33%

6,81%

6 Months

4,10%

-4,85%

5,07%

7,58%

A similar pattern has emerged over longer time periods, too. In the twelve months to June 2009, the average hedge fund returned 6,81% versus the -24,89% of the ALSI. Although the ALBI rose 19,27% over this period, this was largely as a result of the significant cut in interest rates over the last year.

But it is over a three year period that the outperformance of hedge funds over other asset classes is demonstrated. During this period, the Blue Ink All South African Hedge Funds Index increased 12,25% annualised, while the ALSI and ALBI increased 4,24% and 7,59% respectively.

The key reason for hedge fund outperformance on a 3 year basis is capital protection during both the equity and bond bear markets that occurred during this period. During bull markets, they may underperform, as evidenced in the 1 year numbers versus bonds, but their ability to participate more heavily in the market upside versus its downside, has created an outperformance over the different cycles.

In terms of a prediction for the rest of the year, the big question remains the future direction of equities. Bonds are likely to remain under-performers, while cash rates continue to come down. If the recent run in the equity market continues, equities will be the top performer on the year, but there remains a high risk of a pull back, which could lead to it being the under-performing asset class on the year. In this context, hedge funds are likely to be either the top performer on the year (if we get an equity pullback) or second best performer (if the equity run continues).

I am confident that hedge funds will produce the most stable performance over the year. The ability of hedge funds to offer good upside participation with low downside participation fits well with the mindset of many retail investors. Typically, a retail investor wants the best return at no risk. While no investment product can deliver on this, the payoff profile of hedge funds should help minimise the need for the difficult decision that most investors are bad at – namely, that of timing the switch from one asset class to another. Hedge funds can provide the retail investor with a solid base around which to build his/her portfolio. Most investors here would likely do this through a fund of hedge funds in order to minimise any of the perceived risks of investing in hedge funds.

From the institutional point of view, investors tend to be more specific in their hedge fund allocations.

Rather than use them as a separate asset class, they are used as satellites to core equity or core bond exposure. This can be particularly useful when, for example, equity valuations are looking expensive, but other asset classes such as cash and bonds are not particularly attractive. Rather than moving out of equities, the institutional investor is able to allocate to a protected equity type of strategy such as equity long short where they should get better downside protection, but still participate in any potential equity rally to some degree.







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