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Improving pension fund outcomes: a case for hedge funds (Part 2)

Research findings show that a portfolio of select hedge funds in a Regulation 28 portfolio can contribute to a better outcome for pension fund portfolios.

“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.

Read: Improving pension fund outcomes: a case for hedge funds

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.

Source: Citywire

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.

Disclaimer

This document is intended for information purposes only and none of the information contained herein constitutes investment advice or a recommendation, solicitation or offer by Asset Protection International (Pty) Ltd (“API”) to buy or sell any financial product. The information contained in this presentation has been prepared without consideration of the investment objectives, financial situation, or particular needs of any particular recipient. Any investments mentioned in this document may give rise to substantial risk, including the possible loss of principal value, and are not necessarily suitable for all investors. This presentation should accordingly not be considered as a substitute for the exercise of your own judgment or for obtaining independent advice based on your personal requirements and circumstances. Although all precautions have been made to ensure the reliability of data and information contained herein, API cannot guarantee the reliability thereof.

Past performance referred to in this presentation is not necessarily indicative of future performance. Similarly, forecasts contained in this presentation involve risks and uncertainties which may result in future performance, outcomes and results which differ materially from such forecasts. You are accordingly cautioned not to place undue reliance on any historical data, general information or forecasts used in this presentation.

API does not accept liability for any loss, damage (direct or consequential) or expense suffered by a recipient as a result of undue reliance placed on any information contained herein.

Information used and material referred to herein are subject to copyright and may not be reproduced or used (other than for information purposes) in any way unless prior written permission has been granted by API or the appropriate copyright owner. The presentation may not be distributed to third parties without prior written permission from API.

Asset Protection International (Pty) Ltd is an authorised financial services provider, FSP 768.

ADVISOR PROFILE

Jesse Morgans

Asset Protection International

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“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.”

Which local hedge funds are recommended?

End of comments.

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