Hedge funds help

2012-07-14 08:42

Looking for an investment strategy that is more flexible than a unit trust?

A hedge fund is simply an investment strategy, explains Stephen Brierley, head of hedgefunds at Symmetry, Old Mutual’s multimanager investment business.

A hedge fund is able to invest in any asset class and is far more flexible than a unit trust, which is limited to the rules set by the Collective Investment Schemes Control Act (Cisca).

As hedgefunds operate in a less regulated environment, they can set broader investment mandates than a traditional unit trust fund.

A hedge fund can invest in equities, and its can trade the futures market, the currency markets, the bond market and the cash market in its search for optimising performance.

A hedge fund can also “short” a share or an index, which means the fund can actually make money in a falling market, or at the very least protect an investor’s capital.

A traditional fund manager can only go “long”, which means they have to hold a share even if they are concerned about short-term market movements.

Another advantage is that a hedge fund can “leverage”, which means it can have more exposure to the market than the value of the fund.

This is done by investing in the derivative of the share rather than the actual share.

This means the fund has exposure to the share by paying a deposit (or margin) without actually having to buy it.

With a “long” position, the fund manager is hoping that at the end of the contract the actual underlying share price will be higher than the purchase price and therefore make a profit.

With a “short” position, the fund manager hopes that the share is trading at a lower price as the fund manager has actually sold the share with the hope of buying it back at a lower price.

Brierley says hedgefunds are the ultimate stock-picking fund as a fund manager can take positions on their preferred shares and are not constrained by a relative weighting to an index.

Cisca limits the maximum exposure a traditional unit trust fund manager may have to a specific share.



How it works

An equity hedge fund manager selects around 30 shares that he or she believes will deliver performance over time.

However, the manager is concerned about the general market volatility over the short term.

The fund manager can then, using derivative products like futures and options, short the FTSE/JSE index, which in effect means they have sold the index in the hope of buying it back at a cheaper price.

If the market does fall during the time that the short position is held, then the fund manager will make some money out of the short position to offset the losses on the portfolio of shares, thereby protecting the investor’s capital.

Another strategy that a hedge fund may use is pairs trading.

Here the fund manager uses their stock picking skills to make money from both falling and rising shares.

For example, the fund manager may prefer resources to retailers and takes a bet that Sasol will outperform Truworths.

The fund manager may buy Sasol and go short on Truworths.

If Sasol goes up and Truworths falls, the manager scores on both shares.

But even if the market as a whole falls, the manager expects Sasol to be more resilient and for Truworths to fall further.

The bigger fall in Truworths offsets the losses in Sasol.

It’s a relative value gap bet.


Regulation
One of the concerns with hedgefunds is that they are not regulated by the Financial Services Board.

This means that there is not the same level of protection for the investor as is the case with unit trusts.

Therefore, one needs to thoroughly investigate a fund manager before investing.

While the products are not regulated, the fund manager is regulated under the Financial Advisory and Intermediary Services Act under sections specific to the hedge fund industry.

“Although hedge funds are not currently available in the unit trust space, the hedge fund industry is working on a framework to include them in the future,” says Brierley, who explains that while unit trusts have been around for decades, hedge funds are relatively new and people do not always understand the use of derivative instruments, leveraging and shorting.

“We need to make sure they can be regulated properly.”



Accessibility

Most hedge funds have a minimuminvestmentrequirement of at least R500000 and therefore are not aimed at the retail market.

Hedge funds tend to deal mostly with institutional clients such as pension funds and wealthy individuals.

However, there are Fund of Hedge Funds, which invest in a variety of underlying hedge funds that are more accessible to the public if bought through a life “wrapper” such as an endowment, for example.

Pension funds and retirement annuities are allowed to invest a maximum of 10% into hedge funds and multifund managers like Symmetry use hedge funds as part of a building block in creating a total investment solution for clients.

Fund of Hedge Funds is a safer way for an individual to invest as they are diversified across a range of hedge funds and the investment manager offering them has performed the research into the managers.

Although hedge funds are not available on a unit trust platform, many asset allocation or real return/absolute fund unit trusts use hedging strategies to protect investors’ capital.

For example, funds that focus specifically on capital preservation, such as Allan Gray Optimal Fund and the Prescient Equity Defender Fund, use certain equity derivatives that are allowed by Cisca to reduce their exposure to the equity markets when they are concerned about the market trend.


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