Fund Fit

Speaker 0:
Welcome back to the second session of the Fund Fifth Summit. Today we're discussing hedge funds and their role in client solutions and portfolios. I'm joined today by Marius Fenwick, wealth manager at WEA Matthew Pounds, portfolio manager at Lori Capital, as well as Melvin Lloyd, portfolio manager at Nate.

Speaker 0:
Welcome to you all. So, Marius, perhaps we can start off by unpacking two typical client scenarios from which we can decide whether hedge funds would be appropriate for them. Or perhaps not. In your opinion,

Speaker 1:
I think if we approach clients who look at solutions, um, I think we try and differentiate between post retirement and pre retirement.

Speaker 1:
So I think if we could look at those two scenarios, maybe where we look at a client that's Post Re, uh, well, pre retirement, um, heading towards retirement and one post. And, um, I think I sketched a scenario of let's also look at a retail client, not a ultra high net with client that will probably go to hedge funds directly instead of the instead of the unit trust route. So for a for a Preti, Um, I think I sketched a AAA client 48 years old. Um sitting with about 4.5 million rand in retirement funding,

Speaker 1:
Um, waiting for inheritance of just short of 4 million rand, considering repaying his bond of about 1.7. So he probably have investable free reserves of quarter 2 million rand if he settles the bond and then monthly free cash flow. Apart from retirement funding, um, of about 30,000 rand a month, um, into voluntary investments. The second one guy in his retirement, um,

Speaker 1:
late sixties, sitting on on on a living annuity of about 8.5 million rand got free reserves of about 4 million rand in unit trusts and about 2 million rand in a retail bond.

Speaker 0:
So Matthew Marius has sketched two very different clients one pre retirement, one post retirement. Take us through your funds at Lori and how they could possibly be appropriate for both of these clients. Um,

Speaker 0:
so obviously it's worth kind of maybe, you know, um, clarifying in this conversation, we'll be talking about the traditional long, short, uh, hedge funds. That's typically what you find in the South African universe. Um,

Speaker 0:
and you know, we have the view that these are great vehicles to you know, both grow client wealth, so to produce real returns over time to produce, um, equity like returns, But it lower levels of volatility. And we think, you know, lower levels of volatility generally lead to better client outcomes and behaviour.

Speaker 0:
And the reason why you know hedge funds are able to do this is because of the tools that are at our disposal to both enhance return but to also manage risk. So these are things like the ability to short the ability to alter nest and gross exposure. We can take advantage of special situations in the market. Um, so this is literally is kind of the, you know, our tool box that we use to produce these client outcomes. Um,

Speaker 0:
it's an important point that you know, different. Even in the long, short space. Different hedge funds can be appropriate for different client portfolios and outcomes. Um, so if I take the example of of Lori, we've got three hedge funds. We've got a market neutral, which is kind of like our lower risk option. Um, our long short, which is, you know, sits in the middle, and then we've got a higher octane version of that long short, which we call the aggressive. Um,

Speaker 0:
so if you kind of loop that back into, um, Morris's examples of those clients, you take client one. You know, they're 48 years old. Um, you know, they they're still saving. They've got a long term, uh, you know, um, plan. They're receiving discretionary funds. You know, we think an allocation to something like the aggressive, you know, which is great, you know, provided great growth over time about, you know, close to 16% per annum since inception

Speaker 0:
at about the same levels of volatility that you would find in an equity investment. So we think that kind of allocation makes a lot of sense. Um,

Speaker 0:
but if you take, you know, client number two, that's that's you draw down or they've got an annuity portfolio. 68 years old are still, you know, long term, a relatively long term horizon. But they are drawing down on that income. Something like the neutral or the long short um, which have produced about 5% will return, uh, since inception,

Speaker 0:
but at manageable lower levels of volatility. So I think that works really well in in annuity portfolios.

Speaker 0:
um, in the pre retirement space, you know what's great about South Africa is the legislation has allowed,

Speaker 0:
you know, a an investment into, um, hedge funds. Even in the in the in the compulsory space you can allocate, I think up to 10% in hedge funds, 2.5% per manager or notice is 90 which we can discuss in a bit more detail, you know, is is opening up the, um hopefully opening up the opportunity for unit trust to invest in hedge funds. But in the in the compulsory space, you're not constrained. Um, and if you look at in the US, you get endowment funds that have, you know, real return objectives also in drawdown effectively,

Speaker 0:
you know, they allocate up to 30 to 40% to hedge funds. So there's kind of global precedent for, you know, using hedge funds in size in in portfolios where you're trying to beat inflation. You're trying to produce a return, but you are actually drawing down on those portfolios. So it really depends on each longshore fund how it's managed, what its net and gross exposure is, where it will find an appropriate fit in a client's portfolio.

Speaker 0:
So, Marius in South Africa, it seems as though there's a lower allocation, generally toward hedge funds. Is there perhaps time perceptions of hedge funds with regards to fees, or perhaps risk that might be misconstrued?

Speaker 1:
I think I think there's a few challenges. Um, I think hedge funds in the retail space is is quite new. So I think from advisory kind, I don't think, uh, from an advisory point, I don't think all the advisors are fully aware of the structure of hedge funds. Um,

Speaker 1:
the the they fit in a portfolio, et cetera, et cetera. I think the big challenge as advisors to advise clients as far as any portfolio is because they're not just hedge funds. Um, we've got to deal with a lot of a lot of factors. Um, so we've got the the investors investment persona and we've got a We've got a personality persona that we've got to deal with and the one issue with with hedge funds, and it's also, I think, a a function of press that's got a lot of a lot of focus on

Speaker 1:
on on on fees. Um, and there's a big B for P a funds that are extremely cheap. So you've got pasa funds on the one side that are extremely cheap. And hedge funds by nature are are very, very more much more expensive. Um, so that that that's one resistance barrier. And to convince a client that paying a fee of a five or seven or a 9% per year, um, this is one where you can get at 25 bps as far as a as far as a PSA fund is concerned, um, is a challenge. Um,

Speaker 1:
so that's the one. And I think there's a perceived

Speaker 1:
feeling of risk. Maybe. I think even now as we speak, there's a lot of hype in the in the US regarding further regulation on hedge funds because there are a lot of funny things happening now. We've got to differentiate between the South African hedge fund space and the US hedge fund space. But in the broader terms, they still seen under the same under the same banner. So there's a bit of negative con uh uh, negative feelings on hedge funds from A from an investment perspective

Speaker 1:
and then, um, as a big a big, big stumbling block at this stage is is fees, because if we if we do a proposal to a client, then there's six or seven or eight funds in it. It shows each underlying funds

Speaker 1:
fees over the last over the last year. So if you're competing against the equity fund that's set between a one and a 1.5% or whatever, and if you then see a AAA fund with a, um, with A with a, uh, a fee of between five and six, or between seven and 9% for a given period, which we're sitting at the moment, um, you know that that that's that's quite difficult to explain that to a client and justify, um, you know, going for that?

Speaker 0:
Absolutely, Absolutely. Thank you, Maria. So,

Speaker 0:
um, it seems as though, you know, with the hedge fund, you've got a broader tool box or a broader set of tools that you can make use of, um, capturing alpha, which requires a unique set of skills, perhaps from a net of fees perspective. Hedge funds are justified, right? So II, I think you know, um, Morris's points are are are valid, and it's a talking point that we that we see out there in the market. You know, I think we make we make two points generally about about the fee debate. I mean,

Speaker 0:
when you're assessing a fund's appropriateness for a client's portfolio or its ability to meet a client outcome. You know, looking at that on a on a net basis always makes sense, right? You know, these fees are not are not charged on on the Net outcome, and then you charge fees. The the Net outcome is after fees. Um, and you know, as I mentioned earlier, the kind of stats have borne that out. So,

Speaker 0:
you know, a long short band has beaten the market at lower levels of volatility. The aggressive has

Speaker 0:
levels are volatility similar to the equity fund. But you know, it's produced returns substantially higher than the equity fund. So the value is is, is there on an after fee basis? I think that's the first point we'll make the second one. and we we won't shy away from this. And I think the industry is, you know, transparent the the TRS or, you know, the total expense ratios are higher. Um, and that is for, you know, the level of intensity that it takes to manage hedge funds. So your research, uh, capability has got to be a lot greater.

Speaker 0:
Your training engine is bigger. Your your back office in operations is significantly more complex than it would be in a traditional, long only environment. And and in the South African context, especially, capacity is constrained. You can't run 100 billion rand, you know, hedge fund.

Speaker 0:
So, you know, the intensity of managing one rand of hedge funds is completely different to that of managing one rand of long only portfolios.

Speaker 0:
And that kind of is the driver of that, that high expense over time. Um, but again, we kind of always sort of reiterate the the net fee benefit that we've seen. Yeah. So perhaps Matthew, then you can speak to the benefits of being a small, smaller manager and being able to capture certain market opportunities that larger, longer only funds wouldn't be able to capture. Yeah, so? So I mean, he hedge funds have a number of tools. Um,

Speaker 0:
you know, we kind of divide it up into into four. Really, It's it's It's having constant access to cash so we can find opportunities in the market. We can deploy cash very quickly. We don't have to sell. That's that nimbleness that we talked about the ability to short that's predominantly about managing risk. Um, but it's also taking, you know, um, pair trades, taking advantage of special situations. Um, you know, when a holding company spins off a subsidiary, um, these are things that kind of long only funds can't really exploit. Um,

Speaker 0:
with this, we're also not constrained. So if we find an opportunity in a you know, distressed debt or or a preference share, you know, we don't sort of box ourselves into one

Speaker 0:
specific strategies so we can take advantage of those.

Speaker 0:
And then we nimble so not only an asset size, but because of the tools that we have to alter net and gross exposure, we can kind of change our risk profile quite quickly. So that's really kind of the benefits that we that that we have So Malvin. Then I just want to understand and the solutions that an A When when would a hedge fund allocation be appropriate? And then how would you tie it into a pre and post retiree?

Speaker 0:
Yeah, So the thing is when you know hedge funds are are and and, you know, they've already alluded to this. But hedge funds is not just for pre retirement products or, you know, all post retirement products. You can use it, uh, for both,

Speaker 0:
um, and also across different risk profiles. You know, um, Matthew mentioned the their market neutral fund. If you look at that particular fund, you know, over the past decade, it's been it's had volatility, you know, in line with your average medium equity fund. And the long short has been typically, you know, over that same period from a volatility point of view between, uh, the average high equity balance type fund and the S a equity market as measured by the cap.

Speaker 0:
Um, but it's not to say that those portfolios can only be used in those risk profiles. It depends on what's what's your objective for that particular portfolio that you're putting together and obviously, what you're blending with that particular hedge fund in a solution. So you could potentially use the the market neutral fund

Speaker 0:
in an even, uh uh uh, you know, a more aggressive portfolio, and you can use the long short in a you know, less aggressive portfolio again. It's just how you construct that portfolio. Um, and what you're trying to achieve, What are your objectives? Um, you know, when it comes to putting that portfolio together.

Speaker 0:
So then, Matthew, I want to understand. With regards to your qualifying hedge fund and your retail hedge funds,

Speaker 0:
we had a, uh a higher net worth clients say, for example, they would be able to allocate to this fund. What is the qualifying criteria there? Yeah, so I think you know, it's a It's a great point that, um, Maurice mentioned earlier. Um and it's about the kind of education gap or the access gap that the retail environment has in South Africa. Um, so retail investor funds which were introduced,

Speaker 0:
I think is a great idea, because what it does to a large extent, is it standardises hedge funds? OK, so you mentioned earlier the the kind of blow ups that you've seen in the US. You know, these are funds running huge growth, huge net. Um, you know, um running substantial risk. Ok, The RF legislation caps gross exposure at 200%.

Speaker 0:
Um, you know, there are requirements. It kind of creates a standardisation in the industry, which I think is great for the the retail investor to, you know, um, cross that hurdle.

Speaker 0:
Um, So if you look at our at our RF funds, that would be the neutral and the long short, those have got, you know, 20,000 rand, you know, minimum investment. So, you know, very accessible. They're on platforms. Um, you know, there's there's no real hurdle. If you look at the qualifying investor product, that's got a A minimum investment, um, of a million rand, you know? So your client, that's, you know, I think the first example was getting inheritance. You know, that kind of, uh, pot of money is perfect for for a lump sum investment.

Speaker 0:
Um, what we found actually, is that that fund the aggressive fund, we've never really breached the 200% gross limits. So actually, we are looking to make that a a rough product because there's no reason why it should be a qualified investment fund. We haven't really, you know, um, exploited the difference. Um, but I think it's a it it really You know, South African investors can be,

Speaker 0:
um, you know, quite pleased I think with the developments that have been in our industry to actually open up this access because even in the US where

Speaker 0:
you know, I spoke about the wide range use of hedge funds. That's really the institutional space. Um, it's not really in the retail market that these are used. Um, so I think we sort of pioneering in this country a little bit on that front. Um, So then I wanna understand Malvin, the certain the the solutions that you're offering at, uh, in a which ones would be most appropriate for the clients that were put forward.

Speaker 0:
Word by a And then again, I'd also like to understand how costs measure up between a medium equity, um, offering and and the hedge fund the hedge fund offerings that you put. Yeah. So the thing is, in terms of your the, you know, the Preti, um, client and and assuming that client, you know contributes towards an a AR a as an example,

Speaker 0:
which obviously needs to comply with regulation 28. So there you've got a maximum of 10% allocation to a hedge fund with a further maximum of 2.5% allocation per hedge fund. So what you can essentially do is in that 10% allocation. You can have a nice you know, blend, diversify your manager risk and still have exposure to, you know, could potentially be two different strategies or, for example, long, short or market neutral. Again depends on on what you wanna achieve with that 10% hedge fund allocation and what you're trying to achieve overall,

Speaker 0:
Um, and then on the living annuity side, we think that hedge funds are actually potentially quite a good fit in a living annuity. Given that sequence risk, given the fact that client is is, um, you know, constantly withdrawing an income from that particular portfolio. But there you don't have limits in terms of your allocation to hedge fund, so there can be again a a higher allocation.

Speaker 0:
But again, overall, what are you trying to achieve with that portfolio? And we put a portfolio together that should, um, produce that, uh, that objective, uh, over a certain period of time. I think that's that's what important. It's not just about the the hedge fund, um, it's about the overall portfolio and then also just in terms of fees and I mean, Marius, uh, you know, mentioned that is that,

Speaker 0:
you know, even when we speak to clients and we construct these portfolios, you know, clients invest in in those portfolios, you know? So you you you also need to have a portfolio that the client is willing to invest in, um, and on the fee thing, uh, or or or the fee topic. I mean, at the end of the day, we are also seeing, you know, clients that are you know, they understand, um, the benefits of of having a hedge fund in the portfolio. They understand that the performance is net of fees and they are more comfortable to to, um to have the hedge fund exposure in the portfolio.

Speaker 0:
Uh, but at the same time, there's also clients that that's, uh, you know, as Marius also alluded to, You know, if you see T, I CS or 456 7%. Um, that does become AAA challenge in in getting that hedge fund exposure in the portfolio. Even even if it does add quite, you know, a lot of benefits in in the portfolio. OK, and then Malvern, perhaps when looking at your hedge fund manager, uh, from a track record

Speaker 0:
people and process perspective. Perhaps that's more on the due diligence side. But what are some of the qualitative and quantitative aspects that you're looking at? Yeah, so that's that's very important. I think. You know, we at innate invest we don't just do an investment due diligence, But we also do an operational due diligence, which I think is very important when, when investing in, you know, not just hedge funds, but, you know, general long only funds as well.

Speaker 0:
So typically on the, uh, investment due diligence, we'll look at the your, uh, philosophy process the team ESG risk management, et cetera. And then on the, uh, on the operational due diligence side, the ODD, which is conducted by our operations team, they will essentially

Speaker 0:
and look at things like the compliance, their trading process, their tools and systems, uh, their functions that they outsource. And also the the third parties that they outsource these functions to and those are just a few that they look at. But that's obviously also very important. And then, I think, just in general, investing in hedge funds, um, and not just specifically in rs, uh, but in F as well Is that you know, you should look at the manager, their, um their experience,

Speaker 0:
the track record of the fund. If they say that, they, you know, they aim to protect capital, Go and have a look at, for example, events like the global financial crisis and, you know, March 2020 see if the fund actually protected capital risk management is absolutely key leverage in the portfolio. Look at their, um, their gross exposure, their long exposure over time. The the short book, What is that primarily used for risk enhancement or risk mitigation?

Speaker 0:
Um, liquidity is very important. Um, position sizing both on the long side and the short side is very important. So all those things are, you know, are things that one really needs to understand Very well. I think that's where the benefit of AD FM come in is that we really spend a lot of time trying to understand

Speaker 0:
and those, um, those components, uh and then making sure that if we do choose to put a fund in a portfolio that all those things have been covered and that we're happy with it. Matthew, perhaps you can comment on some of the points that, uh, that Melvin highlighted. You know, uh, I think it goes back to Morris's earlier points around getting retail invests comfortable with hedge funds. And so I agree. I think you know, DF MS or, you know, skilled intermediaries have a big role to play here. Because

Speaker 0:
if you're an IFA and you're selecting a hedge fund, um, you know, you are taking reputational risk in the sense that you're investing in a maybe a more well perceived, more complex product. Um, it's maybe not as much. Uh, you know, the familiarity isn't there. So, you know, to sort of bridge that gap, Um, I think requires, you know, the DFM environment. I think it's an important, um tool. Because

Speaker 0:
hedge fund managers in South Africa are are all very different, you know, to to, um, Melvin's point, we we run quite differently. Our our styles are quite different. Um, you know, the use of shorts is can risk mitigate, but it can also risk enhance it to understanding how people are doing that. You do need to do quite bespoke, detailed due diligence on a hedge fund manager more so than

Speaker 0:
let's say, in the long only environment where I suppose you've got more guard rails, right? There's only so much a long only manager with a specific mandate can actually do so. That is where I think, you know, um,

Speaker 0:
skilled intermediaries DF MS really play an important role.

Speaker 0:
So, Matthew, now, with all all of this taken into consideration, what have been the flows, what have the flows been looking like? And are you seeing greater interest? Um, in the in the hedge funds that Lori is offering and it is regulation supporting or constraining the interest in in the hedge funds that you offer. So So we're definitely seeing a lot more interest. You know, I think I think the

Speaker 0:
the last, you know, 24 months or 36 months has seen a lot of volatility out there in the market. You know, you've had the war in Ukraine. You've had high interest rates in the US we had, you know, um, last year, you know, markets generally produced very poor returns. Um, you know, the S and P was negative. Uh, the was pretty flat. There was a nasty drawdown, you know, mid year. And I think the S, a hedge fund space delivered exceptional returns. Um, you know, if you look after the last three years,

Speaker 0:
uh, you know, hedge fund returns are sitting in the twenties. Um, and that's, you know, we were actually positive throughout that drawdown period. Uh, last year. So, you know, I think the the sort of case for them have been pretty explicit. Pretty clear. So you are seeing a lot of interest. Um, especially I think, from the DFM space, where, as I say, I think there's an acknowledgement of the value of hedge funds and their role to play in in in portfolios. So you're definitely seeing that the institutional space, you know, there were some,

Speaker 0:
you know, early clients in the institutional space that use hedge funds. And again, you know, they're increasing the allocations because I think they've seen the value. Um, and it's working quite well.

Speaker 0:
And then regulations has been slow. You know, we thought kind of the the the RF legislation would really open up flows.

Speaker 0:
But as we've discussed, there's an educational, you know, journey that has to take place. I think that's happening. Um,

Speaker 0:
but board notice 90. We really want to kind of see what impact that has. Because, um, unit trusts are the main vehicle for for, um, you know, a lot of investments in the S A. And I think this ability to include a hedge fund in unit trusts is is hopefully gonna be a game changer for flow? OK, so you mentioned then that through different market cycles, different market scenarios and with different clients, um, with their with their unique biases that they have,

Speaker 0:
there'd be more interest in certain hedge funds than than others. That's right. So, you know, our market neutral fund, for example, is seeing a bit of interest. Um,

Speaker 0:
because you've had such a volatile environment, you've had potentially the acknowledgement that equity returns may be potentially lower. Um, going forward. Um, you're seeing, you know, a lot of uncertainty around asset levels and and potential drawdowns.

Speaker 0:
So we're seeing, you know, you kind of do see interest oscillate between you know, the growth side of our hedge funds. When, when you know, people are feeling, you know, a little bit more positive, uh, versus kind of, Let's say the more, um, capital protection focused funds. So at the moment, I think, you know, you sort of on that on that more risk averse mentality at the moment. Um, but I say just generally, I think, you know, because of the kind of the value add of the last, especially the last 36 months. But I think

Speaker 0:
actually, over the last 10 years, or or or or or longer I think SAH funds have been quite unique in terms of what they've delivered.

Speaker 0:
So thank you very much, everyone for unpacking your hedge funds atrium, Matthew, the client scenarios, um, Maus and the solutions that you have had innate appreciate your time.