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Improving pension fund outcomes: a case for hedge funds

A portfolio of select hedge funds in a Regulation 28 portfolio can contribute to a better outcome for pension fund portfolios.

The much-debated “Regulation 28” restrictions imposed on retirement funds have made investors feel increasingly uncomfortable with having large exposure to either the local economy or the local stock market, despite its large exposure to rand-hedge stocks.

Investors who are able to have greater direct offshore exposure in their investment portfolio may choose to exploit this flexibility in what is a very different state of affairs compared to many other points in our democracy. Traditionally Regulation 28 portfolios have had enough flexibility in their mandate to generate real returns for investors over the long-term. Within reason, we may need to question whether or not the current environment has detracted from what was traditionally an appropriate set of restrictions as determined through Regulation 28.

The flee to cash has been prominent and increasing over the last several years. Investors have defaulted to “safe assets”, thus largely and arguably abandoning their long-term financial plan. With interest rates at a multi-decade low, cash is no longer the “safe haven” that it perhaps once was because inflation is expected to return.

The question remains, under the current Regulation 28 restrictions, what can investors and independent financial advisors do to improve the long-term outcome of pension funds without abandoning long-term growth assets.

Research on the inclusion of South African retail hedge funds in a Regulation 28 portfolio is hard to find or largely absent for those who are seeking clarity through empirical evidence.

Inhouse research has suggested that it may be time to give attention to the traditionally alternative hedge fund industry in South Africa.

What does the evidence show?

In order 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.

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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