An innovative multimanaged alternative investment strategies fund, designed to protect investors from some of the underlying risks of hedge funds, has been launched in South Africa.
The Investment Solutions Multi-Manager Alternative Investment Strategies Fund, the first local multimanager alternative investment strategies fund of its kind, safeguards investors from the potential liability of short-selling and leveraging — two of the more risky alternative investment techniques used by traditional hedge fund managers.
The ability of traditional hedge funds to offer investors smooth, consistent return streams in poorly performing markets due to their low market correlation has increased their popularity and proved their worth. Today there are approximately 37 funds registered with the Hedge Fund Association in South Africa, compared with a mere handful a few years ago. These funds have approximately R6-billion in assets, with an estimated R12-billion market exposure.
“Despite increasing demand and activity, there is still little regulation of the hedge fund industry and, consequently, investors are largely unprotected from the numerous risks associated with this important asset class,” says Geoff Blount, head of manager research at Investment Solutions, South Africa’s largest multimanager.
“Although traditional hedge funds have historically succeeded in their objective of achieving absolute returns irrespective of market conditions and their ability to hedge away from market risks, investors need to be aware that a stable return does not imply no risk or low risk,” says Blount. “Typically, investors have either over- or underestimated the perceived risks associated with traditional hedge funds.”
Blount says the risk associated with leveraging occurs when the investment manager borrows money against current investments to make further investments. If these investments are unrewarding, the loss is also leveraged into the portfolio.
Short-selling of securities, especially in a bear market dominated by declining equity values, introduces the risk of loss in value. It occurs when the portfolio manager goes short by selling an asset he or she does not own. If the price of the asset falls, the investment manager profits as he or she can buy it back at a price lower than it was sold for.
However, the risk arises when the price of the asset appreciates and the investment manager potentially faces unlimited losses until he or she can buy the asset back at the now higher price and close out the position. In this instance, investors stand to lose not only their investment, but may under extreme circumstances also have to pay in to cover the losses suffered by the investment portfolio.
“Investment Solutions has spent the past year refining a legal structure that provides investors, which have an appetite for alternative investment strategies, with better protection,” says Blount.
“Diversification is imperative in reducing the risks of investing in traditional hedge funds. A multimanager approach facilitates diversification and the spread of investment risk across many underlying traditional hedge fund managers, using various alternative investment styles, strategies, approaches and philosophies, diminishing the possibility of investment loss,” he says.
Combining alternative investment strategies (such as long/short equity, managed futures, fixed income arbitrage, property hedging) results in favourable risk-return characteristics.
According to statistics on JP Morgan’s CSFB Tremont Hedge Fund Index, the annualised monthly standard deviation (a measure of risk) of this multimanaged alternative investment strategy was 8,9% compared with 16,2% for equities.
Investment Solutions, a subsidiary of Alexander Forbes, says its unique multi-managed alternative investment strategies fund reflected volatility of only 4% over the past three years compared with 22% equity volatility.
Another advantage of the multimanager approach, according Blount, is that strict risk controls at portfolio and product level, using Investment Solutions’s sophisticated compliance and monitoring system, are conducted to protect investors against potential investment losses.
“Professional investment manager selection is also key to risk reduction,” says Blount. “Knowing the traditional hedge fund managers well and understanding the risks they are undertaking are important in minimising risks. A multimanager, such as Investment Solutions, has a full-time dedicated investment manager research team, including investment manager research analysts that focuses solely on analysing and selecting investment managers.
“The focus is on key qualitative factors within the traditional hedge fund manager that may affect that manager’s performance, such as staff changes and understanding the specific portfolio risks of that hedge fund.
“Business risks of traditional hedge funds also need to be considered,” says Blount. “A well-capitalised business is crucial to the success of a hedge fund, as are well-run back office resources, which are often lacking with new start-up funds. A lack in this regard is often responsible for many start-up funds having to close.”
“We believe we have the best possible offering to make investing in traditional hedge funds a less risky bet for investors,” says Blount. — I-Net Bridge