Latest Hedge Fund Composite shows assets class offers stability

The latest Blue Ink All South African Hedge Fund Composite (the composite), which tracks the performance of around 100 hedge funds in South Africa, reveals that contrary to popular belief, local hedge funds are consistently delivering strong returns at relatively low levels of risk.

According to the composite, the average South African hedge fund posted gains of 11.57% for the year-to-date (to 30 September 2009) and 11.79% for the 12 month period to end-September. In comparison, the JSE All Share Index posted an 18.56% gain for the year-to-date, but just 7.70% for the 12 months to end-September.

*Volatility is the annualised standard deviation of returns over three years.

However, it is over a three-year period that the outperformance of hedge funds is clearly demonstrated. During this period, the Blue Ink All South African Hedge Funds Composite increased 41.33%, while the JSE All Share Index delivered a total return of just 21.32%. The All Bond Index performed marginally better than equities with a 25.62% overall return while a high interest rate cycle saw cash deliver a 33.55% return on investment.

According to Kevin Ewer, portfolio manager at Blue Ink Investments, the strong returns by local hedge funds are made even more impressive when one considers they have been generated at relatively low volatility levels - measured using annualised standard deviation of returns.

Over the three year period to end-September 2009, local hedge funds recorded a volatility measurement of just 4.03%, compared with 8.21% for the All Bond Index and a massive 20.90% for the JSE All Share Index. Cash predictably offered the most stable returns over the period.

Ewer says the figures demonstrate that hedge funds not only provide a stronger return in the long term, but also provide more stability for investors. “The returns on the JSE have been exceptionally strong this year, yet this has been due chiefly to the fact that stocks were coming off a very low base.”

“While the JSE is now trading above levels seen just prior to the collapse of Lehman Brothers, the future direction of the market is still uncertain. Equities could close the year anywhere between 5% and 45% higher, whereas hedge funds look set to deliver a more stable performance, closing somewhere between 12 - 17% higher.”

He says that over the last 12 months equity movements have been based on global sentiment rather than earnings. “The risk facing equity markets is still very real as stocks have been priced for perception despite the global economic outlook remaining uncertain. The market is therefore taking a particularly optimistic view on equities, leaving itself open to the possibility of further downside.”

Ewer says hedge funds are expected to produce the most stable performance over the year as they have the ability to offer good upside participation with low downside participation, helping to shield investors from the worst of market downturns.

“The ability to time the market is the holy grail of investing but there is no guaranteed way to time your switch from one asset class to another. This is precisely the reason that hedge funds are able to provide the retail investor with a solid foundation around which they can build their portfolio. For investors that want to diversify their risk even further, the best way to do this is through a fund of hedge funds.”

Ewer says that Blue Ink’s fund of hedge funds products reflect a more cautious approach than those offered by single hedge funds, yet are positioned to capture a significant portion of market upside whilst minimising the possible risk from any downside.