Hedge funds offer protection strategy for investors

The results of the Blue Ink All South African Hedge Fund Composite (BIC), which tracks the performance of around 100 hedge funds in South Africa, showed that this asset class continued to offer investors significant protection from volatility during the current turbulent market conditions.

Kevin Ewer, Portfolio Manager at Blue Ink Investments, says that these low levels of volatility provide a compelling reason for the inclusion of hedge funds as part of any investment portfolio.

According to the BIC, while equities have outperformed hedge funds over the last quarter to 31 March 2010, they have done so at far higher levels of volatility. During this period, the average South African hedge fund posted a gain of 2.38% with a volatility level of 1.53%. In comparison, the JSE ALSI delivered a 4.48% gain in the same period but with a significantly higher volatility level of 20.02%.

*Volatility in brackets

Comparing the returns of these two asset classes over a longer time period also reveals that hedge funds have outperformed equities, while also offering much greater protection from downside risk.

The BIC shows that the three-year total return from the JSE ALSI is 14.43% with a volatility measurement of 21.21%. In comparison, the average hedge fund returned 31.26% with a volatility level of 3.58%.

The graph below depicts the return profiles of both the JSE ALSI and the average South African hedge fund over 3 years from March 2007 to March 2010. Besides highlighting the outperformance of hedge funds over this period, it also clearly illustrates their significantly lower levels of volatility compared to equities.

(Click here to enlarge)

Source: Blue Ink Investments

According to Ewer, these lower levels of volatility mean that hedge funds also provide a safer entry point into the market. “It’s proven that your entry point makes a big difference to your total returns, even when investing for the long term. The less volatile the asset class you are investing in, the less important the entry point is to your overall returns.”

He says the recent financial crisis provided an excellent example of how most people aren’t good at timing the market. “Many people sold out of equities when the market bottomed, and lost as much as 50% of the value of their portfolio in a matter of weeks. They also then missed the subsequent upturn in markets over the last few months.”

Ewer says diversification remains key to a successful portfolio. “It is impossible to know when a bull market will turn bearish which is why it is so important to always maintain exposure to asset classes such as hedge funds that offer a degree of protection in periods of market turbulence.”