Unlocking growth: The rise of hedge funds in SA’s investment landscape

Hedge funds offer investors enhanced diversification, risk management, and the potential for consistent returns in an evolving market.

In recent years, hedge funds have emerged as a prominent asset class within South Africa’s financial landscape. Traditionally dominated by equities, bonds, and property, South Africa’s investment environment is now embracing hedge funds’ unique characteristics and potential benefits. This article explores the rise of hedge funds in South Africa, their advantages, and the implications for investors looking to diversify their portfolios.

What is a hedge fund?

Like other collective investment schemes (CIS), hedge funds pool investors’ money and appoint a professional manager with the necessary qualifications to invest in shares, bonds, and other securities in line with the fund’s investment mandate, much like other multi-asset CIS funds.

Unlike traditional unit trusts, hedge fund managers have additional tools to enhance returns and manage risk, allowing the asset class to generate returns in both a rising and falling market. These additional tools allow hedge fund managers to respond dynamically to market conditions, making the asset class an attractive option for investors seeking capital protection, consistent returns, and greater diversification.

Key characteristics of hedge funds

Source: Peregrine Capital

Why include hedge funds in your investment portfolio?

Hedge fund managers focus on generating absolute returns for investors, meaning they seek to generate positive returns regardless of market conditions.

As a result, the asset class behaves independently of the broader movements in financial markets.

By including hedge funds in your investment portfolio, you could enhance the risk/return profile and provide an uncorrelated return stream. This component of an investment portfolio could assist in limiting losses when markets fall and potentially help to enhance returns in a low-return environment.

Regulatory environment

Hedge funds in South Africa are administered, managed, and protected by a network of highly qualified, independent individuals and entities who serve as gatekeepers of investors’ capital.

In April 2015, South Africa became the first country in the world to implement comprehensive regulation for hedge fund products. These new regulations allowed hedge funds to fall under the Cisca (Collective Investments Schemes Control Act) and be formally registered as collective investment schemes alongside traditional unit trusts. This allows for greater transparency, liquidity, and risk control measures for investors.

The regulatory framework mandates the disclosure of key information, including fees, performance history, and risk profiles. This transparency allows investors to make more informed decisions, which is critical in a market often perceived as complex and opaque.

SA’s hedge fund landscape

In South Africa, 213 hedge funds are managed by 11 management companies. Only 39 retail hedge funds are available for investment on key platforms.

In 2023 alone, South African hedge funds attracted net inflows of R6.24 billion, bringing total assets under management to R137.9 billion, according to the Association for Savings and Investment South Africa (Asisa).

This growth reflects increasing recognition of hedge funds as an attractive investment component for South African investors.

Common hedge fund strategies

South African hedge fund objectives and strategies can vary widely. Below are some of the more common strategies used locally.

Source: Peregrine Capital

Risk profiles and objectives

Hedge funds range from those aiming for minimal variation in returns – targeting steady, consistent growth – to those pursuing significant excess returns, accepting a higher level of risk.

Understanding a hedge fund’s specific objectives is crucial for investors. Mismatches between investor expectations and fund goals can lead to dissatisfaction and hinder long-term investment success.

Investors must assess the fund’s historical performance across different market cycles. A long track record generally indicates a manager’s skill more than short-term results, which transient market conditions may influence.

Choosing the right hedge fund

Selecting the appropriate hedge fund requires careful consideration of various factors, including understanding your client’s risk tolerance and investment objectives.

1. Assess objectives: Understanding the fund’s return objectives and the risks involved is crucial. This alignment ensures a better fit between the investor’s expectations and the fund’s capabilities.
2. Evaluate historical performance: Long-term performance across different market environments provides insight into a fund manager’s skill and consistency. Investors should seek funds with proven track records, particularly during varying economic conditions.
3. Compare risk-adjusted returns: Analysing risk-adjusted returns enables investors to assess potential outcomes relative to the risks associated with various funds. This comparison allows for informed decisions that align with individual risk appetites.
4. Understand fees and structures: Hedge funds have varying fee structures, with the key elements being the management and performance fees. Investors should carefully review these costs, as they can significantly impact net returns. Transparent fee structures are a hallmark of reputable hedge funds.
5. Conduct due diligence: Investors should undertake comprehensive due diligence when selecting hedge funds. This includes assessing the fund manager’s experience, the robustness of their investment strategy, and their track record in various market conditions.

Peregrine Capital’s hedge fund strategies

Peregrine Capital is South Africa’s first and largest hedge fund manager.

The boutique asset manager primarily manages two strategies:

Peregrine Capital High Growth H4 QI Hedge Fund

This is a multi-asset, high-equity fund with a flexible mandate (moderate risk).

The High Growth Fund aims to create long-term wealth for investors by investing in the team’s best investment ideas.

The High Growth Fund is South Africa’s first fund to produce over 100x return on capital for its investors since its inception in February 2000. (Currently 150x initial investment). This has been achieved by providing investors with consistent positive returns over time, at a reduced level of volatility and drawdowns compared to peers.

Peregrine Capital Pure Hedge H4 QI Hedge Fund

This is a multi-asset, low-equity fund (low risk).

The Pure Hedge Fund aims to deliver consistent positive returns above inflation while reducing the volatility and limiting the negative returns that an investor experiences.

Since its inception in 1998, this fund has never experienced a negative return year, showcasing a commitment to stability and consistent growth.

The future of hedge funds in SA

Recent economic challenges, including the Covid-19 pandemic, have highlighted the importance of diversification. Hedge funds, with their ability to employ various strategies, offer a way to navigate volatile markets and protect capital.

Despite the progress made by hedge funds in South Africa, investors still have significant room for growth and understanding. Educating potential investors about the benefits and strategies associated with hedge funds can foster greater acceptance of this asset class.

Hedge funds have emerged as a dynamic and essential South African investment landscape component. Offering diversification, risk mitigation, and the potential for enhanced returns, the asset class increasingly appeals to a broader range of investors.

As the understanding of hedge funds deepens and regulatory frameworks evolve, these investment vehicles are well-positioned for growth. By educating investors and aligning strategies with individual financial goals, hedge funds can play a pivotal role in enhancing overall portfolio performance and achieving long-term financial success.

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