“Shouldn’t we have more offshore exposure?”
Investors continue to express concern regarding the state of South Africa’s fiscal and monetary issues. Despite the added volatility that can come by an increase in offshore exposure for a rand-denominated investor, investors are asking the question as to how they can increase their offshore exposure.
Some investment professionals have been very vocal about the state of affairs in South Africa and have openly promoted taking your money offshore whilst others have cautioned against taking such an extreme view at this point in the market cycle.
Where does this leave investors? What are they to believe?
The last five years have been some of the toughest years in decades
The local vs offshore debate is likely to be heavily debated for some time to come whilst in the meantime pension funds are restricted to the Regulation 28 limitations. Over the last five years, local multi-asset high equity funds (commonly referred to as balanced funds) have struggled to deliver the returns that investors have traditionally become accustomed to. This period of underperformance has been extreme and unsurprisingly it has led to a large outflow from multi-asset funds into cash and income funds.
The chart below shows the inflow of money into cash and fixed income funds over the past several years whilst the trend towards multi-asset funds have been declining since 2014.
For investors and investment professionals alike, it’s worth reflecting on just how difficult this period has actually been for local balanced funds.
Be careful when abandoning balanced funds based on their five-year performance
Investors should be careful when abandoning balanced funds because of their five-year underperformance. Markets understandably move in cycles and this cycle of underperformance should transition into a new market cycle at some point in the future.
The question that pension fund investors may ask themselves is how they could improve the outcome of their investment within a Regulation 28 portfolio and without abandoning their exposure to balanced funds?
The answer may be found in the local hedge fund industry where select hedge funds could be used as a diversifier within a Regulation 28 portfolio.
What does the evidence show?
To understand if hedge funds can improve the outcome within a Regulation 28 portfolio, we need to first see what the numbers suggest.
As a starting point, one needs to select four hedge funds with long-term track records. Each of which can receive an allocation of 2.5% to maximise the allowable 10% allocation for a Regulation 28 portfolio.
The four hedge funds we selected were based on the following points:
- A long-term track record with transparent data.
- Stable investment team.
- They offer a retail class of hedge fund.
- The funds needed a reasonable level of assets under management.
- The investment managers are independently rated on their long-only unit trust funds which have the same management team that runs their hedge funds along the same process. We feel this adds credibility to their investment team, business model and research capabilities.
The next step was to select an independently rated long-only multi-asset balanced fund with a long-term track record. This fund will represent the remaining 90% of the Regulation 28 portfolio, which can later be amended to include other multi-asset balanced funds. We note that Balanced Fund A is the largest multi-asset balanced fund in South Africa which is highly rated and has achieved a real return of around 8-9% per year since its inception in the late 1990s. We, therefore, give ourselves a highly competitive benchmark which we need to improve on through the use of hedge funds with small exposures at 2.5% per hedge fund.
The graph below shows the comparative performance of the respective funds from October 2008 to July 2020.
Source: API research
The chart below shows the “Hedge Only Portfolio” which represents an equally weighted portfolio comprising the four chosen hedge funds, against Balanced Fund A. The performance of the “90/10 Portfolio” is also included for comparative purposes.
Source: API research
We can see from the short summary of the research findings that a portfolio of select hedge funds in a Regulation 28 portfolio can contribute to a better outcome for pension fund portfolios.
To view the research please click here.
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