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Sunday August 07 2022
Familiarize Yourself with the Sophisticated Option of Hedge Funds Before They Arrive

The Star  November 26, 1997

by John Spira


      It hasn't been easy to keep up with the growing array of investment options spawned over the past year or two.

      The proliferation of these options has demanded that increasing attention is focused on how best to invest your money. With the launch of each new unit trust, you have surely searched your soul for an answer to the conundrum: is my capital yielding me the optimum benefit?


      Such uncertainty has been compounded by the new-found freedom to invest abroad. "Should I or should I not?" is an easily answered question relative to "In which of the thousands of unit trusts should I invest?"


      With hindsight, one should have met such dilemmas by being prepared; by anticipating what was ultimately bound to happen, thereby easing the pain when the time to decide materialised.


      Few, of course, did - which is why so many heads are constantly being scratched.


      Mistakes are lessons waiting to be learned, prompting a quest for what may be next in the way of new investment options lies on the near horizon.


      My prediction? Hedge funds.


      South Africa's Dion Friedland, who has made an international name for himself as a hedge fund guru, last week staged a hedge fund conference in Johannesburg.


      It was attended by many local investment managers, suggesting that little time will elapse before this investment vehicle makes a domestic appearance.


      Hedge funds are, after all, a $300 billion industry which is growing at 20 percent a year, and with between 4000 and 5000 active hedge funds in existence. And fads prominent by the US take little time before they are emulated here.


      Familiarise yourself with this pending investment option, so that when it arrives you will know what your are looking at and are able to benefit sooner than might otherwise have been the case.


      The good news is that hedge funds will offer the investor something over and above what has been available in the past. The bad news is that all hedge funds are not the same, implying that the array of additional options will further exacerbate the difficulties surrounding the decision-making process.


      Which is another good reason for getting to know what hedge funds are about ahead of their arrival.


      The following are the principal characteristics of a hedge fund:


Many, though not all, hedge funds strategies tend to hedge against market downturns;

Hedge funds are flexible in their investment options. Thus, many hold short positions and make extensive use of derivatives.;

Hedge funds benefit by heavily weighting the fund managers' remuneration towards performance incentives, thus attracting the best brains in the investment business;

Most hedge funds are highly specialised, relying on the specific expertise of the manager or the management team;

The performance of many hedge funds is not dependent on the direction of the bond or equity markets - unlike conventional unit trusts, which are generally fully exposed to market risk;

Hedge fund returns, over a sustained period of time, have outperformed equity and bond indices with less volatility and less risk of loss than equities; and

Investing in hedge funds tends to be favoured by the more sophisticated investors who have lived through and understand the consequences of sharp stock market corrections.

Friedland is at pains to highlight the misconception that hedge funds are highly volatile.

      "According to a study by Van Hedge Fund Advisors Incorporated, global hedge funds outperformed mutual funds in return, with lower risk of loss when risk was measured on a similar basis for both hedge funds and mutual funds.


      "The study looked at more than 1600 hedge funds for five years ended December 1995. Furthermore, over that five-year period, almost all hedge fund styles earned significant excess returns compared to mutual funds for less risk of loss."


      When hedge funds are offered in South Africa, the question uppermost in your mind will be how to select the best hedge fund manager.


      What does Friedland, whose funds of funds invest in a variety of hedge funds, look for in a hedge fund manager?


      "I look for a manager who can convince me that he or she has an edge. Once I am able to understand why the investment manager has an edge - be it through having access to superior research or information flow or to contacts in industry, Wall Street or among his investors - I can then understand why the investment manager is likely to outperform his or her peers.


      "Many times I've heard of investors who will not consider a new manager unless he has a five-year track record. I do not agree with this approach. In the past I would have missed out on some of my best-performing fund managers if I'd waited for long-term performance records.


      "Research seems to indicate that hedge fund managers tend to have some of the best returns during the initial few years of running their funds - before they attract a lot of money and have to start delegating decision-making and management of parts of the portfolio to others.


      "Also, during the first few years the typical hedge fund manager is hungry and ambitious and will work backbreaking hours to succeed."


      Had hedge funds been operational in South Africa prior to the October crash, a good number of investors would have been afforded the downside protection they did not get.


      Hopefully, next time around a lifebelt of this type will be readily to hand.

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