Hedge funds are an alternative asset class, using different investment strategies to enhance performance returns or reduce risk. Hedge funds can improve diversification by having a low correlation to traditional asset classes. This is made possible by employing a wide range of non-traditional investment strategies, such as leverage (borrowing) or net short (selling) positions.
Gyongyi King, chief investment officer at Alexander Forbes Investments, debunks some misconceptions surrounding hedge funds and offers a better understanding of how they work.
1. Myth: Hedge funds are risky
Alongside the misconception that hedge funds offer limited value for a higher cost relative to traditional asset classes, they are also perceived to be an excessively risky asset class. Contrary to this popular belief, South African registered hedge funds are relatively conservative when compared to their global counterparts and they generally seek to provide a steady return profile for investors.
In fact, hedge funds have a strong record of protecting capital during periods of market underperformance and providing investors with a steady return profile, when compared to other asset classes.
“Hedge fund exposure allows you to increase the likelihood of achieving your investment goals in both strong and weak markets, as markets require a strong focus on risk management. Hedge funds can provide an additional lever to spread investment risk by focusing on performance return that is independent to, and not correlated to, traditional capital markets. The risk control is embedded in hedge funds,” King said.
2. Myth: Hedge funds are unregulated
The financial services industry is heavily regulated and hedge fund investments are no different. In response to the global financial crisis in 2008, the National Treasury and the then Financial Services Board released a framework for regulating hedge funds in South Africa. In 2015, hedge funds were officially regulated and declared as collective investment schemes in terms of Section 63 of the Collective Investment Schemes Control Act 45 of 2002 (CISCA). All hedge fund products and their systems and processes need to comply with all regulation. This means that hedge funds operate in a highly regulated environment and are required to comply with all legislative requirements proposed by CISCA. This ensures a high level of transparency, client protection and a high standard of governance.
3. Myth: Hedge funds do not incorporate environmental, social and governance (ESG) considerations into their investment process
Sustainability is a trend in the investment landscape, and hedge funds are also required to implement ESG factors.
One of the core beliefs that underpins our investment approach for investment success is sustainability. Seeking superior long-term returns entails investing in sustainable and attractive investments, avoiding any negative shocks resulting from ESG risks. “We believe that underlying asset managers who consider and evaluate the risks and opportunities arising from incorporating ESG factors into their investment process are better positioned to make quality long-term investment decisions. When engaging with asset managers, we require that ESG initiatives are incorporated into their decision-making investment process,” King said.
“While hedge fund managers can deploy the same investment strategies that traditional asset managers can, hedge funds offer more opportunities because of the wide array of strategies they are able to employ. This means their mandate is relatively more extensive and therefore their investment opportunity set far broader.”
“Hedge funds play a crucial role in helping South Africa manage risk more effectively in our portfolios, optimising investment goals within acceptable levels of risk,” concludes King.