Fund Fit

Speaker 0:
Hello and welcome to this fun fit session today I'm joined by Stuart SP, wealth manager at Grason Wealth. Alan Yates, head of distribution at Peregrine Capital as well as Jacques de Cock, portfolio manager at Martin Optimal. Welcome to you all. Thank you very much.

Speaker 0:
So, Stuart, I'm gonna kick off with you. What is your thinking around the use of hedge funds and what are the typical client concerns or perceptions that they might have with the use of these instruments within within their portfolios? Uh, in my experience, I I've certainly found that hedge funds

Speaker 0:
really are an important part of a client's toolkit. Um,

Speaker 0:
I think in terms of concerns, there's historically been a concern that they are really expensive, that they are that they're risky.

Speaker 0:
But, um, I I think also the one concern is that that I found is that a lack of knowledge, particularly amongst advisors, and I think that could also lead to to individual investors or it's not been recommended to individual investors.

Speaker 0:
OK, so you as a wealth manager, what two typical client scenarios would you find where the use of hedge funds may be appropriate? Certainly. Um, the the one example I I will use is somebody dying leaving a bequest to, uh, a testamentary trust. Um, and in particular, to help somebody from the old alma mater to for, uh, for students that need bursaries.

Speaker 0:
Um, an example. Say 7.5 million. And they want to now have about 100,000 per student. And the idea is that they would then, um, allocate between 3 to 5 students a year.

Speaker 0:
Um, the other option, uh, is somebody retiring?

Speaker 0:
And, um, let's assume an amount of 3.55 million. The person takes their tax free commutation amount full tax free commutation amount of 550,000, and the balance goes into a living annuity. Um, that is definitely something where one can look at at using, um, a hedge fund.

Speaker 0:
OK, so two ultra high net worth or high net worth individuals. One that has passed away, and one who has pre retirement. So perhaps looking at the time horizon and risk tolerance of these two, they are high high, um, net worth. How would hedge funds then be appropriate? And perhaps you can take us through the hedge funds at Capital sure. So I mean, I think

Speaker 0:
if we go to maybe let's start with the first example and and and use a fund to to to highlight there. But if we we're looking at something where it's obviously you want kind of intergenerational money to continue for as long as possible, Um, there's a hurdle rate required here, Let's say, at C p I plus three or four in order to fund, um that, uh, that Bursary programme, et cetera.

Speaker 0:
I think the appeal of a hedge fund product And I mean, when I think of our funds, what would would probably be, uh, a decent fit is something like our pure hedge fund. The intention of that product is to provide the investor with a lot of stability and consistent returns over time. So it's not. It's not a case of Let's try and,

Speaker 0:
uh, shoot the lights out kind of six and out. Strategies here. We don't want to do a 30% year or 40% year and then have a a negative 20. It's all about that consistency of returns. Um, so I mean, pure hedge is an example. I think over the last I don't know, 1 to 15 years, we've definitely done, say, CPR plus four or five. Um, but you've you have in that time period, there's been no negative return, Uh, from from from the fund.

Speaker 0:
Um, And what that does allow that investor to do then, is to know that I've, you know, I've put the money into something that is consistent and stable. Um, and it will be able to accommodate those those consistent withdrawals over over a long period of time.

Speaker 0:
It's never gonna be a case of, you know, I'm gonna double the money on day one, but that's not the intention here. I think you know, if if that was the intention this this product isn't isn't appropriate. So I think it's something that gives that that stability and that consistency of return is very valuable to an investor like that. Um, if we go to the the the the second example of somebody retiring,

Speaker 0:
obviously, when when a person retires, they've done the hard yards. They've they've saved, they've they've made their money. And now it's a question of how do I protect this? But at the same time, how do I make enough? You know, How do I grow to a point where I can live off it for what could be a very long period of time? You know what I mean? It's, uh, these days it's not a case. If you retire at 30 at 65 you know you've got a cover of 10 or 20 years of expenditure, it might be 30 or 40 years of expenditure.

Speaker 0:
Uh, and I think the things you've got to look out for there is obviously number one big drawdowns because, you know, if your capital base is, let's say, the three million rand

Speaker 0:
and you put that all into equity markets. Equity markets have a 2008 or a covid experience, and you're down 40 or 30%. It's very difficult to come back from there and to still generate that that income stream that the client needs. So again, I think a hedge product because it the hedge fund is able to protect on the downside. And I think that's kind of the key differentiator between a hedge fund and and and a traditional long only fund is that we can provide that protection and we can generate those returns even when markets are forward

Speaker 0:
and or going sideways. Um, I think a hedge fund can be can be very beneficial to the investor by being able to produce those returns. And look, I mean on the street there, depending on what his income requirements are there, you know, let's say he's AC p I. Plus, uh, maybe it sounds like a six or a seven Here. You are gonna have to obviously go further up the risk scale to to generate that. But you got to try to balance it with with the the the need to be able to protect that capital. So I think something like a high growth fund,

Speaker 0:
um, which definitely does take more equity content than our pure hedge fund. Um, but at the same time, I think it's still very much focused on that capital protection, you know? I mean, I think that's what investors come to er, particularly come to four. I can't speak for all hedge funds, but our investors come to us to say I want to participate in the upside. You know, I wanna make sure that I'm generating C p. I s plus four and +45 or six,

Speaker 0:
but I don't want to have to sit through the big drawdowns. I don't want to have to, uh, you know, compound off a lower base. If you can just protect that capital, I think, as a as a fund manager, it means then you don't have to really swing the bat too hard. If you

Speaker 0:
protected the capital at the bottom, you can just compound off a off a higher base and a maximise sense. So in in those two instances, I I think the funds would be a good fit in this particular example with the living annuity, the person or the example that I used, the person did need to start with a relatively high drawdown,

Speaker 0:
so that automatically puts the the the the capital under pressure. So under normal circumstances, as Alan said, you know you don't want to within a living you don't want to have to experience drawdowns. But, uh, the important thing is, yeah, you've got that tension between

Speaker 0:
you know you don't have a a AAA high risk tolerance, but you you need to take on risk. So it's a difficult thing. So it's that tension between having to to get the returns because you need the returns for your capital to grow. And I think that's very important for the work of a of a wealth manager,

Speaker 0:
you know, to try. And once you understand what the person's risk profile is an understanding of risk, you might need to say to them, Sorry, you know, But you do need to to actually take on more risk. Because if you don't, if you aren't prepared to take on more risk, you you're gonna run the risk of, of of running out of capital or your income drawdown ultimately hitting the gap and and reducing. Absolutely.

Speaker 0:
So then, um, Alan, I'd like to understand, In scenarios like these, what tools do you have at your disposal when you're managing these hedge funds? Of course, you've spoken about put protection. Um, long shorts. Perhaps you can take us through these. Yeah, so I mean, I think very broadly if you think of, uh, a traditional long only product versus a hedge fund. What's the difference? Really? The only major difference on the hedge side is that we can we can use the short book, and what that means is that we can obviously

Speaker 0:
either buy protection in the form of shorting an index or shorting a basket of shares, uh, or shorting individual shares. And then we can use derivatives to buy protection for the assets that we run. And I and I think those two things are critical to the success of a of of a hedge fund because it is around mitigating risk. So So I mean and And we started at the point saying, You know, uh, investors often think a hedge fund is a risky product,

Speaker 0:
and again, it comes just to that education element. I would I would counter that a well managed hedge fund is a significantly less risky product, but it is a more complicated product, and and and that that is absolutely true. And so you need to have people that know how to run these things that have experience running these things that are experienced in in derivatives and experienced in the short book. Um, but for us, those two elements allow us to make sure that we're not always

Speaker 0:
in the market, that if we feel that the market is is either gonna trend sideways or down, we can still generate returns for investors without having to take that beta or that market risk in the portfolio and and protect against those drawdowns. So so I mean, when we talk about that, I think that's what investors come to us for. You know, if if the market's down 40 and the hedge fund is also down 40 you're not adding value. If the market's down 40 and your hedge fund is down 10 or 20 or or hopefully even up 10 or 20 then you

Speaker 0:
a lot of value to that client's life. Um, and I think, you know, I mean, if I, uh, again going back to our two different products, that that pure hedge fund which has been around now for 25 years, we've never had a negative year in that fund, and I think that speaks to that consistency, But at the same time, it means that we're not. We're not doing years where we're doing twenties and thirties and forties, uh, and outperforming the market when the it it it it's running very hard. I don't think that's that's not why we're adding these things

Speaker 0:
to to these portfolios. You can get that exposure elsewhere. Um, whereas our high growth fund. The intention there is to certainly outperform the market, and I think we've done that well, um, but again, it's that if you can do it off a a higher base, if you just don't suffer the drawdown, you don't have to take all the extra risk at the top. So, uh, it is, I think it's it's it's It's that risk management tool that actually is the the, uh, the secret weapon of the hedge fund. Absolutely, Absolutely.

Speaker 0:
So, Jacques, now, in your solutions that might and optimal How would you implement typically the use of say, for example, a long shore, or possibly a market neutral, um, hedge fund into your solutions? And what are the considerations that you need to take into account from a quantitative and qualitative perspective?

Speaker 1:
Yeah, thanks, Chloe. So and then, just to add to to what Stuart said, a very important factor that we realise in in in doing the analysis on the hedge funds that we have done up to now is that if you're looking at the long only space there, there are ways of trying to mitigate risk. The only problem is you only have A You have an inclusion or exclusion, Um, of a specific asset class. Um, so generally your

Speaker 1:
mitigation of risk comes at the cost of returns. Where, um, with hedge funds, That's not necessarily the case. Um, they have other levers and other instruments that they can use to, um, mitigate risk to a certain extent, but not give away, um, the return objective. And that's very important. When we created our products,

Speaker 1:
um, one of which was specifically designed for a retired client withdrawing between four and 7%. Um, but can't take that amount of risk because, like Stuart said, I mean, in the first five years, you are at massive risk. Um, and if you have a bad sequence of returns within those five years,

Speaker 1:
um, you can dig a big hole that it's just almost impossible to get out of. So if you can get those returns that you need from higher risk investments, but at a much lower, um, much lower volatility sequence, it really, really helps. Um, and that's where the, uh, pure hedge came in. And that's one of the building blocks that we use within that, um, portfolio.

Speaker 1:
Um, and that's also how we use how we use that, um, that specific product for those specific clients with those specific needs. Uh then, on the other hand, we we have the ST Bold product, which is a product that is targeting a lot higher return. Uh, but as Alan said it, it does come with a little bit more risk. But, um, not as much as you would expect, given the returns that it's that it's

Speaker 1:
providing. And that is then for specific clients that need that extra return. But not um, not taking all of the volatility that comes with if you, let's say, went into a equity only type of mandate.

Speaker 0:
So then, Jacques, perhaps you can just touch on the qualitative aspects, particularly from a track record perspective, a people and a process perspective When looking at a hedge fund manager.

Speaker 1:
Sure, no, it's it's extremely important. Um, Alan, you both mentioned that it's the the products, and the funds aren't overly complicated. But it is more complicated than when viewing a long only, uh, fund.

Speaker 1:
So therefore, there's a lot of research that needs to go into it, and there's as if I look at each one separately. If you look at people, um, you need to know that the manager has number one, their expertise and number two, the experience. Um, this is not just, uh, a a normal business type of thing that if you have seven years experience, you've been through a cycle, and therefore you're good.

Speaker 1:
You need to have the experience of how different, um, derivatives and how different structures react through different, different market cycles. So it's very important to us that a fund manager really needs to know what they're doing and have the experience of doing that through a long time. And it was actually very interesting that in the S a market, our hedge fund managers do have a lot of experience. Um, and all the names might not be as familiar, but when you,

Speaker 1:
uh, drill down and and do the analysis, they they do have a lot of experience. So we are fortunate in that case when it comes to process, Um, it's It's similar to AAA long only type of, uh, process that we look at. But there's extra effort that you need to understand. How does a specific manager get to what they use because different head fund managers also use different structures, um, and different opportunities. So you need to know

Speaker 1:
what those are, how it gets used, the what? And why. For one specific counter you know is important to the fund manager. And that's why we have them to us and to and to the financial advisor. We need to know, how does that fit together? Um, and that's why you also need to know, um, what the strategy is and how the different levels come into that specific strategy. From a track record perspective,

Speaker 1:
you need to have AAA longer term track record when you're looking at at hedge funds,

Speaker 1:
and and you need to know that what you're using that specific fund for, um fits into that mandate. So if the mandate is to have lower risk but, uh, absolute return or AAA return range within a very specific point, it needs to fit that, and it needs to stay within that range, which is important for, um, our product that's focused on market neutral. Um, where for the product that's focused on more high returns, Longer term?

Speaker 1:
Uh, we we are focused on a track record of getting higher returns and relaxing the volatility ban a little bit. But it's important that it's a longer term

Speaker 1:
and that you can see that the that the fund manager has the capability to give you that extra alpha through time. So,

Speaker 0:
Alan, then perhaps you can comment, um, from Paragon's angle with regards to the track record, the process and the people the experience that you have in your team, Um, as well as the appropriateness then of this this, uh, strategies that you have for a specific D f D f M. Sure, Um, but I mean, I I I like the the process people and particularly the track record experience part because we can talk to all of those. But,

Speaker 0:
I mean, I think the management of and and Jo is exactly right. The management of a hedge fund is very different to the management of a long only product. Um, there is a certain set of skills that are needed that are not necessarily needed if you're managing long only money, um, so to to find a a fund manager. And he's And he's also correct in saying that there are a number of experience. I mean, it's not just ourselves. There are a number of experienced fund managers in South Africa who had a long track record of running hedge.

Speaker 0:
And and I think the South African hedge industry actually is is, uh is very high talent density, which is fantastic. Um, so you do need those particular skill sets, you know what I mean? Understanding how derivative structures work, how they price how they move, what the the unintended consequences are on in various market conditions is super important.

Speaker 0:
Um, and then around the asset allocation, etcetera is also very important how you build the overall portfolio. I mean, I think it's often people think OK, cool. Um, you know, you buy all the things that you like and you sell all the things you don't. That's absolutely not how you build a hedge fund to that. That's gonna have longevity. Anyways. The the portfolio management element of it is critical. Um and then I think in terms of process, the other thing to say is that if you look at five different fund managers, we all have five very different processes

Speaker 0:
and and the the interplay between those is is important from AD f m perspective and from a portfolio construction perspective. And I think that, you know, our process. Our process has been pretty much the same for the last 25 years. I mean, for us, we are fundamental bottom up stock selection business. We're not a big macro house, whereas if you talk to some of the other guys, they'll they'll place a lot more focus on on on macro per se and both can work and and both have their place. Um, and I think in terms of people,

Speaker 0:
for me, it's a case of, uh, I mean the appeal of joining somewhere like Peregrine is that I work with very, very smart fund managers. I certainly go home feeling really stupid at the end of the day, but that's fine. Um, but that's what you need with these these these, these kinds of businesses. You want people that are living this as and and are invested alongside clients. And I think you know, we tick the box Well, uh, in that space, Um and then just in terms of

Speaker 0:
overall, where do you head? Where does hedge hedge funds fit into into an advisor's overall portfolio, or AD F. M's offering.

Speaker 0:
Obviously, I'm gonna say, I certainly think this There's there's, there's there's a place for hedge that go that goes without saying But I think that what we have seen and and has been fantastic over the last three or four years as this journey of sort of hedge funds coming into into the retail market has progressed is that advisor. More and more are understanding where where they fit in are understanding the value that they add. And it's

Speaker 0:
been it's been really enjoyable to see you guys get the returns that they're looking for, uh, you know, or or the the outcomes that they're looking for from our product, um, and to just being able to add value to their lives and to their clients lives. I think it's really it's it's it's been fantastic. But now I want to understand. I know Stewart has mentioned, um, two very specific client scenarios from a liquidity angle then

Speaker 0:
and the constrained market universe that we've spoken about and the opportunities that can be exploited in the space

Speaker 0:
do liquidity requirements, um, from a client perspective, then constrain their choice between certain hedge funds. Uh, mainly not I would say. I mean, I broadly, most of us, certainly the the major hedge managers in South Africa all have retail funds. What a retail fund does is prices daily. It's, you know, it's it. It trades daily. So from a liquidity

Speaker 0:
perspective, it's exactly the same as any other C. I s product they're going into, um from an accessibility point of view, most of us are on all the major list platforms. Now, we're in all the various products, so you can access us in living annuity endowments and retirement et discretionary. So I think we've kind of ticked all the boxes in that space. What I do think if we talk about, uh,

Speaker 0:
uh, liquidity constraints is that you will find that hedge managers in general are quite small in terms of our our assets under management. And certainly, I mean, I can speak only for but to say that's an active decision on our part because we believe that flexibility is very important in this in this sort of market. So we we, we we we actively do manage that, Um, but I mean the the the honest truth is that hedge in general? I mean, if you look at

Speaker 0:
large endowments outside of this country, so you know, like the Harvard Endowment as an example, they'll probably have a 20 or 30% allocation to alternatives to hedge funds, whereas in South Africa that number, uh, across the board is significantly lower. So I do think it's got a bigger place to part to play in, in, in, in, in, in generating those outcomes for clients. And, uh, I mean, so we've seen a good pick up, and that's that's been great.

Speaker 0:
So Stuart and I want to understand. Are there any major concerns when you bring up the word he hedge funds with, um, some of the clients? Of course you've got your ultra high net worth individuals that have that scope to be able to allocate, um, to some of these possibly qu. But now mostly, um, retail investment funds where they have that daily liquidity.

Speaker 0:
Are there any other concerns that that clients would have? I think we touched on most of them. Um, the liquidity was historically quite a big thing, um, dealing with clients. But I think if you're dealing with an ultra high network client, there's nothing wrong with most of the clients have the vanilla investments and so on, and you can allocate a certain portion to something that possibly is not. There's no need to have it, um, the the liquidity angle there, but just to I just want to take a step back to to what the guys were saying here. As an advisor,

Speaker 0:
I've been very fortunate to to be involved with D F MS like like Jacque and And when I think back, having been in the industry for a while when we had to make the decisions, you had to try and do the research on the funds, you had to try and do the research on the, uh on the hedge funds and everything and the ability to have somebody like AD f. M has taken the weight off off of my shoulders. I know,

Speaker 0:
and it's amazing to be able you don't. The the the things they've been talking about now are not something that you need to worry about. Now I'm fortunate enough to be able to work closely with the underlying portfolio managers within the D f MS that we use, and it's amazing because we come with a different angle, whether it be tax, whether it be the liquidity angle and look, there might be certain, um, funds that are already in place or risk profile portfolio. This is a inflation plus six inflation plus four portfolio whatever.

Speaker 0:
But depending on the size, you might be able to then tailor make a bespoke portfolio for a specific clients risk. And and I think the benefit not having to worry about all of those little things that they're talking about there and being as involved as you like, depending on what the the nature of the relationship is with your portfolio manager. So, yeah, so it's certainly, I mean for me. I think it's been a one, and I've seen more and more hedge funds being included in in the D. F M model that I've seen and I use.

Speaker 0:
So it it certainly is. And it might not have been the case if I had to do all the research and try and understand the things. So I certainly think it's happening more and more. I agree with what Alan was saying about. It's probably not as much as it should be or could be, but, uh, but I think perhaps there might be a little bit more education

Speaker 0:
for advisor. I mean, we've spoken about this, Alan, but what else do you think is perhaps lacking? Um, that that's constraining the uptake of hedge funds. Um, by financial advisor. I would honestly think, um, education. I think it for me is probably one of the biggest things. And not only the advisors, but the clients as well, you know, And, uh, and and and

Speaker 0:
and giving them access to to that knowledge.

Speaker 1:
So if I can add firstly, thanks to you, Um and, uh, just anecdotally. Also, we, um We went down this road quite a while ago, and we, um, as have had hedge fund exposure here and there. Um, but really, um, in creating the products really had to really drill down deep. And after one of our with peregrine,

Speaker 1:
um, and I got out of the meeting and just looked at each other and went This is gonna take a bit longer than we thought it was going to it. Um and but it's it's that we have the experience and have the capabilities to

Speaker 1:
to discuss, uh uh, um, certain aspects with the managers that specifically programme is is is very forthcoming when it comes to, um sending us data, um, and and and and really understanding where we are and where we are coming from. And uh uh, um, giving us the information and the time of day that that we need is very, um, very important and and makes our lives so much easier.

Speaker 1:
Um, And then also on the on the topic of of, of the uptake, uh, something that was also interesting is because of legislation actually lagging a bit. It was only, um, a couple of years ago that really hedge funds was available and, um, in the retail space now, um, and on lisps and and so forth. And in that

Speaker 1:
clients also and advisors and from AD f m perspective we wanted to see Listen, do these guys really does the the rift space really match up with the space? Are they capable of doing that? And and the liquidity and they prove their metal in there. And and then from there on, you could see the uptake really coming through. So I think it's just a timing perspective and really advisors and D f d f m alike

Speaker 1:
noticing the d f MS and feeling comfortable with saying, Listen, these guys have proven themselves no, in this retail space as well.

Speaker 0:
So now to close off the session. And I know we've been speaking about, um perhaps advisor, um, training or perhaps just bringing advisor and clients up to up to scratch with regards to understanding what hedge funds actually are. Um, what have you What have you noticed? Um, in distribution. So I I'd say it's 90% of my job

Speaker 0:
is around education. Um, and and so it should be. I mean, I I think the answer is First of all, you don't want an advisor to be buying something or recommending something that he isn't comfortable with. And And, I mean, we get we get significant pushback from guys if they don't. If if if I'm not making making it clear, what we do, they're gonna ask me tough questions. And that's great. That's exactly as it should be. Um, I think, yeah. I mean, I think

Speaker 0:
hedge funds were AAA largely, totally unknown asset class, uh, in South Africa for a very long period of time. That is definitely changing. Absolutely. Is changing. Um, but it is a case of, uh, you know, you can't have one meeting with somebody, and and they suddenly feel comfortable with a new product, a new asset class and a new fund manager, because, I mean, we're also a specialist hedge fund manager. So, you know, no one will have had exposure to us if they haven't been in the hedge fund space.

Speaker 0:
Um, so, yeah, it is about education, but I think that's absolutely the way it should be. I think guys want to get to grips to understand the product and say, Is this right for my clients? Is this you know, how will this add value to my end clients? And when they are comfortable with that, then I've done my job.

Speaker 0:
Um, so I mean, I think it's a It's a feature, not a bug. Absolutely. So I think that's a a nice, sweet end of the session. Hopefully, we start seeing a bit more uptake of certain hedge hedge funds in certain client solutions with the F MS and with advisors that are that are, um, becoming a little bit more comfortable with asset loss. Thank you very much for your time. We appreciate your insights