The high levels of stock market volatility over the last few months resulting from natural disasters and continued political and economic turmoil have once again highlighted the need for proper diversification across asset classes, within investment portfolios.
During the month of March, the All Share index (ALSI) gained only half a per cent, recovering from a frightening 6.4% drop mid-month, primarily from the devastating earthquake and resulting Tsunami in Japan. In contrast, the monthly Blue Ink All South African Hedge Fund Composite (BIC), which tracks the performance of hedge funds in South Africa, delivered a 0.64 % return.
“Conservative hedge fund strategies have once again outperformed the ALSI over the short-term, but with far less volatility”, says Eben Karsten, portfolio manager at Blue Ink Investments. The BIC three-month standard deviation to end of March was recorded at just 2%, compared to 9% of the ALSI.
A longer term comparison also reveals a significant outperformance of local hedge funds on both a nominal and risk adjusted basis.
The BIC has achieved a total return of 30.98% over three years, compared with 18.57% from the ALSI over the same period. Over the past year the BIC has returned 8.91% versus 15.15% on the ALSI. However, the one-year volatility of the BIC is just 1.95% versus the 15.99% of the ALSI. High levels of volatility means equity investors who enter and exit the market at the wrong time can suffer extensive capital losses.
Karsten says recent global equity market strength flies in the face of the traditional risk / return relationship. “Notwithstanding good earnings reports out of the US and Europe, the equity markets seem to have ignored mounting geopolitical and sovereign debt risks,” says Karsten. “Investors would do well to remain conservatively invested as we could see sharp equity market corrections in the months ahead.”
Karsten goes on to say that there are a number of varied exogenous risks to markets that could see sharp equity market corrections in the months ahead. “For that reason, we continue to favour conservative hedge fund strategies. Aside from the Japanese disaster investors have had to contend with growing political unrest in the Middle East and North Africa as well as renewed concerns over the European sovereign debt crisis.”
He says that while South Africa and other emerging markets have benefited from these global risk pressures with improved capital flows, the return from local asset classes remained subdued.
Locally all eyes have turned to the fixed interest rate market, where Forward Rate Agreements (FRAs) suggest the South African Reserve Bank will increase the repo rate by at least 50 basis points in the last quarter of 2011. “The renewed strength in the rand confuses the rates outlook somewhat as the Reserve Bank’s response to second round effects of cost push inflation may be delayed,” says Karsten. Foreign investors have reacted to the interest rate outlook by buying R7 billion worth of bonds through March 2011. The All Bond Index gained 0.48% for the month, but was outperformed by the 0.71% generated from Fixed Income hedge funds.
