The reason we opted for a hedge fund as our initial investment offering was twofold – firstly, the overriding objective was to protect investor capital and the hedge fund structure was the most suitable vehicle to achieve this; and secondly, the flexibility afforded by a hedge fund meant we were largely unconstrained in terms of our investment opportunity set.
Since inception in January 2005, the Bateleur Long Short Fund2 has exceeded its investment objectives. The fund has compounded at 14.6%3 per annum net of all fees, well ahead of the JSE All Share Index total return of 13.3% before fees. To put this into context, R1-million invested in the Bateleur Long Short Fund in 2005 is worth R11.1-million today.
Importantly, these returns were generated at significantly lower levels of volatility than the overall equity market. The Bateleur Long Short Fund‘s volatility has averaged 7.8%4 since inception compared to 17.7% for the JSE All Share Index. The fund’s worst single calendar year was during the financial crisis in 2008 when it declined 4.8%. In the same year, the JSE All Share Index fell 23.2%. Although Bateleur Capital has over time expanded its product offering beyond hedge funds and now directly manages more than R9-billion of assets across flexible, long only and global mandates, the attractiveness of hedge funds as an investment vehicle is more relevant and compelling today than back in 2005. Some of these reasons include:
If managed according to their strict definition, hedge funds are designed to protect capital. This can be achieved in many ways, but the most common approach for equity hedge funds is through managing the net equity exposure so that the hedge fund’s returns are not overly correlated to the equity market. The net exposure is managed via the use of shorting individual equities, shorting indices or by using a wide range of derivative structures. Shorting individual equities is not readily available to most conventional long only equity funds and is a key competitive advantage for hedge funds. Our experience is that capital preservation in periods of market stress leads to outperformance over the long term.
Depending on their approved mandates, hedge funds offer the investment manager an unconstrained opportunity set. For example, if the manager was optimistic on the South African equity market, the hedge fund might have more than 100% of the fund’s NAV invested in local equities (by using leverage). Conversely, if the manager was negative on South African equities as an asset class, the fund may be net short local equities. These are extreme examples but highlight the flexibility available to hedge funds.
Of course, it is critical that this flexibility does not jeopardise the overriding capital preservation objective of the hedge fund. The two objectives should be managed symbiotically and not individually.
Advisors can access a multitude of hedge funds across several asset classes such as equities, fixed income and commodities. Each fund offers unique risk, return and capital preservation profiles which in many instances have low correlation to traditional long only funds. Having access to funds with low correlated returns will help advisors build portfolios for all market conditions.
Established industry with full regulatory oversight
The industry has grown up. There are several funds, like ours, that have been around for 15 to 20 years which allows investors to evaluate performance through numerous macro events such as the global financial crisis and the Covid pandemic. These funds are run by established and respected investment managers backed by sizeable teams and significant infrastructure. In addition, since 2015, hedge funds have been regulated under the Collective Investment Schemes Control Act. Investors should accordingly have as much confidence in the oversight and protection of assets as they do any traditional unit trust.
Liquidity and platform availability
Another key difference between 2005 and now is that hedge funds are becoming more readily available on LISP platforms with daily pricing and liquidity. Back in 2005 they were not available on any platforms and there was only monthly pricing and liquidity available. In addition to accessibility, the LISPs also provide an additional filter/due diligence on the broader funds in the market.
If managed according to their strict definition, hedge funds are designed to protect capital.
In 2005, hedge funds were renowned globally for charging high management and performance fees. The key allocators to the industry in South Africa were the hedge fund of funds, who charged additional fees. The net result was the underlying investor was incurring sizable annual management and performance fees when expressed as a percentage of the fund’s total return. This practice has changed materially led by the shift away from the hedge fund of funds industry. Presently, many South African hedge funds can be accessed at management fees like traditional unit trust funds. While performance fees are still common, they are often only generated after surpassing far stiffer hurdle rates than historically, with a high-water mark principle applied.
Despite the positive points highlighted above, it is important to emphasise that not all hedge funds are created equal. It is crucial for advisors to do their homework on the different range of hedge funds available, their approved mandates, their appointed fund managers and their long-term track record. It is especially key to understand how the historical hedge fund returns have been generated – was it through fund manager skill or leverage? If it was through high or excessive leverage, then it could indicate that the fund may suffer significant drawdowns in a challenging market environment.
At Bateleur Capital, we are firm supporters and proponents of hedge funds. Almost 18 years of history operating in this space supports our positive stance. We are currently appointed as the fund manager for three different regulated hedge funds: the Bateleur Long Short Fund referred to earlier, the Bateleur Market Neutral Fund5 and the Bateleur Special Opportunities Fund6. While all three of these hedge funds have different mandates and risk/return profiles, they all have an overriding objective of protecting investor capital.
From inception to the date of writing, all three funds have generated strong absolute net returns in excess of the JSE All Share Index at substantially lower volatility. This clearly advocates our long-held view that the right hedge fund has a relevant role to play for financial advisors, especially in the current uncertain investment environment.
1. Bateleur Capital (Pty) Ltd is an authorised financial services provider, FSP No. 18123 2. Bateleur Long Short Prescient RI Hedge Fund 3. Returns have been calculated using the published fee class from January 2005 to August 2022. The growth of R1m invested in 2005 is based on the published fee class with distributions reinvested. Past performance is not necessarily a guide to future performance. 4. 30-Day rolling volatility as calculated by Bateleur. 5. Bateleur Market Neutral Prescient QI Hedge Fund 6. Bateleur Special Opportunities Prescient QI Hedge Fund