Are hedge funds the right investmentvehicle to protect your wealth?

Hedge vs Multi-asset portfolios

Multi-asset portfolios use different asset classes as a means of diversification. Cash may be used as a risk reduction tool alongside the addition of other classes, such as bonds and property. Portfolio managers may deviate from their strategic asset allocation to position their funds to benefit from anticipated short-term market movements. This is referred to as tactical asset allocation.

In comparison, hedge funds have broader tool sets that can generate positive returns. These tools include the ability to take short positions that benefit in downtrending markets and derivatives that enable selected factor exposure.

Wealth protection and preservation

Hedge funds have often been incorrectly perceived as being too risky for this task; however, hedge funds cover the full spectrum of risk profiles, from very conservative to aggressive, and have the potential to provide better risk-adjusted returns than many multi-asset portfolios.

Below are the various risk profiles and our in-house hedge funds that, from a risk perspective, fall within the high, medium, and low Regulation 28 multi-asset portfolios but offer better returns and capital protection. As per the latest proposed changes to BN-90, these three Regulation 28-compliant ASISA categories will be able to incorporate up to 10% in a combination of hedge funds.

Looking at different risk-return measures

The Sharpe ratio is a widely used measure for reflecting the comparative risk-adjusted returns of portfolios. However, when the concern is about downside risk, which is the case in wealth preservation, the Sortino ratio is a better measure than the Sharpe. The Sortino and Sharpe ratios are both risk-adjusted return measures; however, the Sortino ratio only factors in downside risk – in other words, it measures the additional return for each unit of downside risk. 

The higher the Sortino ratio, the greater the expected risk-adjusted returns, all else being equal. A higher Sortino ratio signifies a higher return per unit of downside risk, while a lower ratio indicates lower negative risk returns per unit. 

Below is a table and chart showing the various ratios for hedge funds and multi-asset peer groups using the JSE/FTSE Capped SWIX as a benchmark for just over ten years, from 1 January 2013 to 28 February 2023. 

Figure 1: Return, Risk and Sortino Ratio 

The Laurium Aggressive Long Short Prescient QI Hedge Fund, which falls on the high-risk spectrum, has the highest beta exposure; however, according to the Sortino ratio, it has the highest expected return for every unit of risk taken, meaning the risk taken is done justifiably and cautiously. The Laurium Long Short Prescient RI Hedge Fund portfolio, which would sit in the medium risk spectrum, has the lowest Sortino ratio of the three hedge funds. However, it is still almost double that of the market and the ASISA categories, meaning more return per unit of downside risk taken.  

Figure 2: Annualised Returns versus Sortino Ratio (Top Right Optimal) 

Lastly, the Laurium Market Neutral Prescient RI Hedge Fund, where market risk has been hedged away resulting in a beta of just 0.2, has on average produced positive returns during down-trending market times. This means it is capable of sustaining wealth through volatility and drawdowns, making it suitable for more risk-averse objectives. In addition, the Laurium Market Neutral RI Prescient Fund has almost half the standard deviation of the equity market with more significant upside potential. The Market Neutral fund has a Sortino ratio of nearly three times the equity market, which means it has done an excellent job of generating positive returns per unit of downside.  

Figure 3: Upside/Downside Capture Ratios (1 Jan 2013 – 28 Feb 2023) 

The comprehensive variety of risk management tools that move beyond shifting asset class allocation, such as the dynamic management of market exposures, derivatives for downside protection and elimination of factor exposure, allows for a more efficient and proactive set of risk management tools. The established SA hedge funds have proven to give investors the best risk-adjusted returns over time, and soon all investors will hopefully be able to obtain exposure to them via their Regulation 28-compliant unit trusts. Holding thumbs on BN-90 changes being introduced sooner rather than later.