Capital protecting hedge funds thrive on market turmoil

Hedge funds come into their own in turbulent markets.

According to Nosibusiso Ngqondoyi, Portfolio Manager at independent multi-manager, Novare Investments, “The benefits of having hedge fund exposure in a portfolio are all the more evident in the kinds of markets we’ve experienced for the better part this year.

“Prevailing economic conditions locally and globally are putting traditional asset class returns under pressure. However, these volatile and low return economic environments are a good backdrop for hedge funds to thrive.

“Unlike long only funds which buy stocks they expect will increase in value, and consequently struggle to post decent absolute and relative returns in an environment where most stocks have run hard with limited to no upside, hedge funds give returns that are uncorrelated or that have very little correlation to the market.”

She added that while hedge funds invest in the same instruments as traditional asset managers, they have at their disposal a greater array of investment tools to express their views and to generate alternative sources of return.

Volatile markets like those currently being experienced present opportunities for hedge fund managers because they can profit in both up and down swings by going short the stocks they believe are overvalued, and long the stocks they regard as undervalued.

“With the proper use of leverage these returns can be amplified. This is done without deviating from the primary objective, which is to minimise risk and protect capital,” said Ms Ngqondoyi.

She added that, to use the correct type of hedge funds, it is important for investors to have the necessary expertise about what managers are doing and why they perform a certain way, their risk profile, as well as their methodology for extracting alpha from the market.

Extensive due diligence is therefore important before making an investment decision to ensure that only reputable managers with proven hedge fund skills are selected.

“Investors should also guard against investing in managers based solely on their track record. It is important to understand how returns were achieved and whether there is a repeatable alpha generating process in place that the manager follows to unlock value.

“Using a combination of different strategies across different asset classes to diversify away from single manager and asset class risk helps to generate smooth and stable long-term returns. We believe it is now all the more important for investors to have exposure to hedge funds, which are often incorrectly perceived to be a highly risky asset class,” Ms Ngqondoyi said.

She added that because South African hedge funds were initially established for institutional clients like pension funds, they are relatively risk averse with a capital preservation focus. They use far more conservative strategies and tend to be less exotic than the complex structures used internationally.

The introduction of stricter regulation for hedge funds as collective investment scheme portfolios by the Financial Services Board (FSB) and the National Treasury should provide additional comfort to retail investors.