Wade Witbooi, Managing Director at Amplify Investment Partners

Could hedge funds save the day in times of uncertainty?

In a volatile market, where global policies can shift overnight and currencies fluctuate daily, hedge funds can provide a powerful tool for investors looking to stabilise returns and capture opportunities that traditional strategies might overlook.

Once seen as exclusive and complex, hedge funds might actually provide stability when markets are shaky. As hedge funds become more regulated, transparent and accessible, particularly in South Africa, financial advisers and investors are starting to recognise the value they can bring to a diversified portfolio.

While the local market remains underdeveloped, largely due to limited awareness and persistent myths around hedge funds, the question is no longer whether hedge funds belong in portfolios, but how best to use them.

The origins of hedge funds: why understanding the history matters

Hedge funds have come a long way since 1949 when sociologist and financial journalist, Alfred Winslow Jones, first combined long and short stock positions to reduce market risk – essentially “hedging” his bets. His pioneering approach outperformed traditional funds and introduced the now-familiar approach to hedge fund management and performance fee structuring.

While strategies have evolved, the principles remain the same: harnessing skill, insight, flexibility and innovation to deliver returns in all market conditions. These principles matter now more than ever. In a world defined by volatility (and in a local market seeking diversification and downside protection) hedge funds offer tools that traditional investments often can’t.

Understanding the origins of hedge funds helps investors and advisers better grasp why these have become such a powerful addition to modern portfolios, including ones here, in South Africa.

Not all hedge funds are the same: what you need to know

The term “hedge fund” is often used in investing, but there’s no universal definition, which can leave people puzzled. While “hedging” suggests protecting capital and reducing risk, that may not always be the case, as not all hedge funds aim to explicitly reduce risk. Some hedge funds are designed to take on more risk in order to maximise the probability of achieving outsized returns.

Hedge fund managers can employ various strategies to achieve the end goal. Hedge funds can short sell, use leverage to amplify returns, or they can make use of derivatives to manage risk. So, are hedge funds about getting rich fast, or are they a more stable option? The answer could be both, or neither. Complex, indeed!

Here are some common hedge fund strategies to help you better understand how they work:

• Equity long/short: This strategy involves buying stocks expected to outperform and shorting those expected to underperform, with the overall position reflecting the manager’s market view.

• Market-neutral: This strategy balances long and short positions to neutralise market swing risk (beta), allowing managers to focus solely on picking the right stocks, regardless of market direction.

• Global macro: These funds focus on broad economic trends such as interest rates, currencies or commodities across various asset classes.

• Fixed income arbitrage: These funds take advantage of small price discrepancies in fixed income markets and often use leverage to amplify returns.

In South Africa, popular strategies include equity long/short, fixed income arbitrage, multi-strategy and market-neutral approaches.

Understanding a hedge fund manager’s strategy is key before deciding if it’s the right fit for your portfolio. As legendary investor Jesse Livermore said: “There is only one side of the market and it is not the bull side or the bear side, but the right side of the market.”

Why should financial advisers and investors pay attention to hedge funds?

Hedge funds aren’t just speculative toys; they’re a versatile tool in a well-rounded portfolio. They can provide true diversification, often behaving differently from equities and bonds, which can help protect portfolios during market downturns. They also help as managers tactically adjust allocations to reflect dynamic economic shifts. And for those looking to add some extra return, certain hedge fund strategies can amplify overall returns without significantly increasing risk. These factors can result in a portfolio that’s both defensive and opportunistic – a powerful combination for investors.

The growing appeal of hedge funds for South African investors

South Africa’s hedge fund market is small, covering approximately only R185 billion in assets within the massive R3.87 trillion collective investment scheme sector. However, the industry is growing rapidly, with net inflows for 2024 reaching a record R11.8 billion, according to ASISA, and nearly double the net inflows in the previous two calendar years.

Since the FSCA introduced regulations in 2015, hedge funds in South Africa have become more accessible to both retail and institutional investors. These regulated structures, like retail investment hedge funds (RIHF) and qualified investment hedge funds (QIHF), now allow access to hedge funds for pre-retirement (Regulation 28), post-retirement and in their discretionary investments across linked investment service provider (LISP) platforms. With the Collective Investment Schemes Control Act (CISCA) now overseeing them, hedge funds are treated as regulated collective investment schemes, offering investors greater transparency and enhanced risk-control measures.

As hedge funds continue to gain popularity, financial advisers are increasingly recognising their potential for delivering uncorrelated returns and capturing upside opportunities, making them a valuable tool for diversifying and strengthening client portfolios.

Where to from here?

South African hedge funds are gaining traction thanks to stronger regulation, growing investor familiarity and innovative domestic managers. These funds are more accessible and valuable than ever. In a world where volatility is the only constant, hedge funds are no longer a “black box”. They’re a versatile “Swiss Army knife” for building resilient portfolios. Ready to rethink your portfolio and improve risk-adjusted returns? We think it’s a Sharpe idea.

ENDS