Recently, hedge funds have been reporting mixed results.
Recently, hedge funds have been reporting mixed results. While many showed weak performances, some funds, including those of Oryx Investment Management, were recording positive outcomes. Even though long/short equity funds declined in July and over the year, the numbers still represent the largest year-to-date outperformance through July for long/short funds over the S&P 500 since 2002.
Still there have been many underperformers. There are several reasons for the diverse performance in the year to date. Volatility has been rife and most asset classes/ sectors have had dramatic inflections at some point in the past 12 months.
Many fund managers had different views on whether ‘it was different this time.’ Many therefore underestimated the effect that the subprime crisis originating in the US would have on emerging and other developed market economies as well as whether commodities could continue upwards despite a global slowdown.
There have been dramatic bear market rallies and short squeezes, some originating from government intervention. Examples of this include the prohibition on naked short selling of certain US equities, emergency Federal fund rate cuts and the JP Morgan (Fed assisted) acquisition of Bear Stearns.
In South Africa, the story is no different. The most common mistake among South African hedge fund managers was the high (and often leveraged) exposure to small cap companies post the listings boom. Managers were unable to exit these positions without dramatic declines in the share prices.
Redemptions in funds with high weightings to these small caps exaggerated the problem. The local market also experienced a violent sector rotation in June out of resources/materials companies and into bank and consumer stocks.
Many fund managers were not positioned for this and suffered losses in June/July as a result. Year to date, the best position to have was a high cash weighting and some exposure to large cap equities via short term trades.
In terms of what the future holds for the South African funds industry, it must be said that the local industry is still in its early growth stages. Hedge funds still comprise a very small portion of the South African investors’ investable universe. We are in a testing environment and the funds that survive will prosper in coming years. In the short to medium term we expect growth for managers who have demonstrated an ability to preserve and grow capital in turbulent and declining markets.
Lack of regulation in the sector may have prevented or dissuaded some investors from considering hedge funds in their investable universe. The regulations that are being instituted by the FSB may help put the industry on more investors’ radar.
In conclusion, those hedge funds where the investment teams’ wealth is more closely aligned with that of their investors will probably perform better in this environment. Prohibiting PA trading as well as basing remuneration solely on profit share will ensure the investment team is as committed to capital preservation in tough times as it is to performance in good times.
By Barry Shamley and Gavin Butcher of Oryx Investment Management
