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An Introduction to The Hedge Fund Industry
Clients in South Africa, unlike clients in other parts of the world, have not embraced alternative types of assets, particularly hedge funds. This could be due to Hollywood’s over-dramatization of additional asset classes, an overall lack of understanding of the various approaches, or even the GameStop quick squeeze. The investment bank market in the United States is over $4.5 trillion in size, but the hedge fund industry in South Africa is only about 0.1% of that size, at just over $6 billion. When adjusted for market capitalization, the scale of the hedge fund sector in the United States is 15 times that of the hedge fund industry in South Africa. This demonstrates the long-held belief in our country that there is a lack of curiosity in hedge funds.
As a result of hedge funds’ ability to employ such a wide variety of strategies, the global investment bank sector has become significantly difficult to manage. Macro/event-driven strategies, long/short equity strategies, multi-strategy techniques, fixed income strategies, relative cost strategies, and merger arbitrage strategies are a few examples of these strategies. The long/short stock market accounts for roughly 60% of the South African economy, making it much easier to comprehend.
The Equity Strategy
The long/short equity strategy is a straightforward approach to equity trading that involves taking long-term investments in stocks that are expected to rise in value and short positions in stocks that are expected to fall in value. A long/short equity strategy seeks to reduce an investor’s exposure to the market while maximising profits from price increases in long positions and price decreases in short positions. A long/short equity approach is an investment strategy that uses short positions to reduce drawdowns while still participating in equities’ upside.
This strategy is ideal for the troubled times we are in right now, and we would recommend using it. Consider the following example, which employs 36ONE’s long/short hedge fund techniques. Since the inception of the 36ONE Hedge Fund in April 2006, the average monthly decline in the ALSI has indeed been -3.2%, while the 36ONE Hedge Fund has only decreased by 0.1%. The ALSI expanded by 3.6% on average during the months it was up, while the hedge fund returned 2.2% during the same period.
Overall, this has resulted in a compound performance review of 15.9% net of fees, significantly higher than the ALSI of 10.5%. This represents an annual improved performance of more than 5.4% over the previous sixteen years.
The Hedge Fund Misconception
One common misconception about hedge funds is the common belief that they have a higher risk of loss than traditional equities funds. While this may be true for more complex hedge fund strategies, such as merger arbitrage or macro funds, traditional long/short equity funds are designed to provide returns with significantly lower risk measures than traditional equity funds. This is because investors can short-sell their stocks, lowering their total exposure to net equity and, in theory, resulting in smaller drawdowns.
Because missing out on the best days in the market leads to suboptimal returns over time, investors are constantly concerned that they will lose money if they do not attempt to time the market. While this is an important consideration, it pales in contrast to making it a priority to minimise pullbacks as much as possible to maximise returns.
Consider the achievement of the S&Amp; P 500 index over time to demonstrate this point. The return on investment for the S&Amp; P 500 was 17.7% from 1930 to the end of 2020. If you ignored the top ten best and worst days of each decade, your return on investment would have been 27.2% lower. This is just an example of how, over time, it is far more important to focus on avoiding drawdowns than it is to be concerned about missing out on upside potential.
As a result, we believe that hedge funds, particularly the 36ONE hedge funds, are appealing funds to include in a client’s portfolio because they generate superior risk-adjusted returns over time by reducing drawdowns and downside risk while also delivering on the upside. As a result, hedge funds are an appealing option for clients to consider.
One popular misunderstanding about hedge funds is that they are strange and difficult-to-understand financial products available only to a select few. The Collective Investment Systems Control Act imposes stringent guidelines and controls on the South African hedge fund industry. To register a hedge fund, extremely detailed procedures must be followed, as well as gross exposure restrictions designed to keep funds from taking on an inordinate amount of risk.
Access is also much easier than in the past, with hedge funds available on the majority of the major LISP platforms, including Allan Gray and Glacier. More people will be able to invest in hedge funds as a result of this.
The 36ONE long/short hedge funds can provide investors with returns comparable to an equity requirement, but with substantially lower drawdowns and levels of uncertainty than the equity mandate. As a result, they are an excellent addition to any investment portfolio. Due to this, overall risk-adjusted returns are higher.