With relatively high equity market valuations and low interest rate environments in virtually all developed markets, South African investors looking for offshore diversification are faced with a challenging prospect in terms of both risk and returns.
According to Kevin Ewer, portfolio manager at Blue Ink Global, Blue Ink Investments’ offshore division, one solution for these investors would be to allocate a portion of their offshore portfolio to global hedge funds, which he believes currently offer far higher prospects of outperforming other asset classes on a risk/return basis, especially over the mid to long term.
“The case for hedge funds has been less clear from a return perspective since the turn of the equity markets in March 2009, but over longer periods of 3, 5 and 10 years hedge funds, across almost all strategies, have out-performed the traditional equity indices with both lower levels of volatility and drawdown," says Ewer. "Positioned correctly within a portfolio, they are able to offer good diversification and return benefits.”
He suggests that investors should be allocating some of their equity allocation to hedge funds with a long-short equity mandate, benchmarked against 50% equity markets and 50% cash. He adds that investors should also be doing a similar thing with fixed income allocations. “There is a lot investors can do here rather than simply being long only that can enhance their payoff profile. They should also then look to make strategic allocations that are uncorrelated to equity markets. This would come specifically from global macro and managed futures type strategies. “
Ewer says that South Africans also need to be realistic about the levels of returns they should expect from investments in offshore hedge funds.
“Low double digit numbers should be considered excellent, while even high single digit returns should be considered acceptable," he says. "There may be some funds that are currently shooting the lights out, but they often are taking high levels of risk. I would urge investors to stay away from them, unless they understand the risks being taken and are happy with the potential downside."
Ewer says that while local investors may still be wary of offshore hedge funds in the wake of the global financial crisis, many of these funds have made massive adjustments since 2008 in the way they approach risk and also their investors.
“One of the biggest problems used to be that many of the longer running funds had always done self-administration and investors were relying on auditors to sign off on valuations at year end as to the validity of the performance.. Post 2008, that game was over. Hedge funds realised no matter who they are, they needed a third party administrator for governance reasons.”
He says there is a lot more transparency now from most hedge funds. “For example, most managers now provide monthly outlines of sector and regional exposures, largest positions etc. This gives investors a good idea of how they are managing the fund. While this transparency is still not to the level that is in South Africa, it will be possible to pick up issues such as changes in style and risk levels.”
According to Ewer, these changes are more market driven than regulatory. “I am not convinced that transparency changes due to any new regulations are that noticeable. It is more a case of managers realising that the more that people know, the less the negative reaction will be in a period of poor returns.”