HOT TOPIC | Why Hedge Funds should be used in conjunction with traditional asset classes
Hedge Funds are regulated by the Financial Sector Conduct Authority (FSCA). The FSCA is the regulatory body in South Africa responsible for overseeing and regulating the conduct of financial institutions and market participants, including hedge funds. It sets the rules and regulations for the establishment, operation, and marketing of these funds, with the aim of protecting investors and maintaining the integrity of the financial markets.
Retail hedge funds are priced daily and have a high-level risk management built in due to the regulations set out by the FSCA.
Hedge funds can offer several advantages when used in combination with traditional investment portfolios.
These include:
Diversification: Hedge funds typically invest in a wide range of assets and strategies, which can help to diversify a portfolio beyond traditional asset classes. This diversification can potentially lower overall portfolio risk and increase returns.
Potential for higher returns: Hedge funds can use more investment strategies and, this can potentially lead to higher returns, particularly during periods of increased market volatility or in environments where traditional asset classes typically underperform.
Higher degree of active management: Hedge funds are more actively managed compared to traditional long only managers. This is done by experienced investment professionals who are constantly monitoring the markets and adjusting their strategies to take advantage of opportunities in the short-medium term. This can potentially lead to better performance than passive investment strategies.
Lower correlation: Hedge funds may have a lower correlation with traditional asset classes, which can provide additional diversification benefits and reduce portfolio risk.
Access to alternative investments: Hedge funds can provide access to alternative investments that may not be available to individual investors, such as commodities, and currencies. Thus, providing additional opportunities for diversification and higher returns.
Below illustrates the benefits of including an allocation to hedge funds within a traditional portfolio.
Three different portfolios were created, the first includes zero hedge funds, the second portfolio has a 10% allocation and the third a 20% allocation.
The analysis above has shown that using hedge funds, combined with a classic mix of traditional assets (for simplicity kept it at equity and bonds), will result in higher performance, lower drawdowns, and decreased volatility.
The OIG range of model portfolios make use of hedge funds to decrease overall volatility, while also aiming to achieve a higher return. Something that has been achieved by all our model portfolios over the medium to long term, and more specifically over the proposed term for each portfolio.
Regulation 28 stipulates that each model portfolio may have a maximum allocation of 10% to hedge funds, with a maximum of 2.5% in a single hedge fund. For portfolios which do not have to adhere to regulation 28 we offer a specialised living annuity product, that can also be used for discretionary investments with a moderate risk appetite. This model portfolio has no limitations on asset classes. We use between 20-30% hedge funds, depending on market conditions. Currently the model is at an allocation of 30% to hedge funds due to the elevated market volatility expected.
Below is the model portfolio product offering at OIG:
