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Sunday August 07 2022
Big Daddy's The Obstacle on This Investment Path

Personal Wealth Weekly February 11, 2000

by Ben Temkin


He wants you to choose unit trusts instead, despite the risks


      Magnum Global Investments chairman Dion Friedland, pioneer of discount stores in SA and international champion of hedge funds, is peeved that the SA regulatory authorities apparently believe unit trusts are a safer haven for investors' money than hedge funds. They especially fear short-selling as an investment strategy (the selling of securities not held by a fund in anticipation of a market fall).


      Strangely, perhaps, the main regulatory authority, the FSB (Financial Services Board), gave the all-clear just last year to scrip-lending by institutions.


      One of the main reasons for scrip-lending is to enable short-selling. Traders borrow shares (or other securities) for a fee and then sell these shares (which, of course, they don't actually own). If, as they hope, the prices of the shares fall, they buy them in at the lower price to deliver to the buyers and then return the borrowed scrip. Because they hold the borrowed scrip at the time of the sale, the sale does not have to be disclosed as a short or bear sale.


      The FSB is expanding the investment latitude of unit trusts and is expected to allow specialised unit trusts to sell short and to use derivative trading. No doubt, then, hedge funds established in SA will be able to unitise and be regulated in terms of the Unit Trust Control Act.


      While the hedge funds wait for this to happen, many SA investors find themselves steered into unit trusts, whose main strategy is to buy shares in anticipation of share prices rising - the strategy of going long.


      As Friedland correctly points out, a long strategy carries with it enormous risks, especially as trusts cannot invest outside their man8pt.


      In the case of growth funds, for example, at least 80% has to be invested in equities at all times. Unit holders in growth funds are, therefore, dangerously exposed to a stock market crash. Their fund managers cannot sell short or take a position in the futures market to protect them.


      Friedland says too that the fixed long strategy makes unit trust performance unpredictable. Fund managers can strive only to perform as well as an index. This is why they will tend to buy the shares that make up the index - or even run index tracker funds.


      Absolute performance - producing a target return for investors - is secondary to benchmark performance. If the benchmark index falls by 30%, then fund managers applaud themselves if their funds have fallen by less than this.


      Magnum's business is managing funds of funds. It selects hedge funds on the basis of the quality of the investment managers in line with the primary aim of most hedge funds: to reduce volatility and risk while attempting to preserve capital and deliver positive returns under all market conditions.


      Magnum funds have an impressive performance record. Typically, the Magnum Multi fund, which was started in April 1994, has had its NAV (net asset value) grow from US100 to more than 200 at the end of 1999. That's compound annual growth of around 15% - in line with its objective of returning 15%-20%/year with low downside volatility and low risk of loss.


      Other Magnum funds have shown even more impressive returns, at the risk of greater volatility.


      But this risk deserves closer attention, and where better to look than one of Magnum's chosen funds, the hi-tech Galleon Omni Fund.


      In 1999, this fund, managed by Raj Rajaratnam, one of the speakers at the FM's international hedge fund conference last November, gained 94,2% (420% since inception in March 1996). It made money from both long and short investments during the year, positioning itself to make money not only if there was a downturn but also if the bubble burst.


      Rajaratnam says the net exposure to the market averaged only between 30% and 40% in 1999. He says about 70% of the returns came from the long side and 30% from the short side. "Our hedging discipline," he adds, "should insulate the portfolio somewhat when another market correction occurs".


      Rajaratnam selects good stocks in preference to trying to time the market. He finds "bottom-up, research-driven stock selection" is the best approach in an investment environment "that has become more irrational, volatile and risky".


      One of the hallmarks of the fund is that it is not leveraged - it never uses borrowed capital. Its risk exposure is also never more than 100%.


      Typically at any time it might be investing 30% long, 60% short and have 10% in cash. If it increased its long position, it would reduce its cash or short positions, or both - it would not borrow to increase any of its positions and so increase its risk exposure to more than 100%. Incidentally, the fund invests no more than 5%-7% of its assets in any one stock.


      If your tongue's hanging out to invest in Galleon Omni or in one of Magnum's funds, pause. You may do so only with offshore funds (you can use your foreign exchange allowance).


      No-one's allowed to solicit an investment from you in this country. The funds aren't allowed to advertise.


      But some of the banks have been setting up hedge funds. There's a hedge fund association and Arthur Andersen and Grant Thornton Kessel Feinstein are members.


      Big daddy makes it difficult to invest, but not impossible.

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