Speaker 0:
Hello and welcome to this first session of the fund fit summit. Today we'll be looking at hedge funds and the way that hedge funds fit into client solutions for financial advisors, as well as the role of hedge funds in D. F M Client Solutions. Today I'm joined by Erin Samuels, independent financial advisor at Woodland Wealth.

Speaker 0:
James Corin, portfolio manager at Capital Management, as well as M. McMahan, portfolio manager at CIA. Invest

Speaker 0:
Welcome to you all, Thank you very much. So, Erin, perhaps we can have a look at two clients scenarios and get an understanding of their risk tolerance, their time horizon and their return objective, and perhaps just see how hedge funds could be appropriate for them in certain scenarios.

Speaker 1:
Sure. So just generally looking at at, um, two typical client scenarios, um,

Speaker 1:
one being pre retiree, relatively young, other one being in retirement, post post retirement and, yeah, you. The goals and the priorities are really different. Um, in your post retirement space, there is the wealth accumulation phase has already taken place. The wealth is here, and it's all about drawdown. It's all about sustainable income. Um, with your Preti, the priorities Look a lot different because you're very much forward looking.

Speaker 1:
Um, and you're looking at capital growth and accumulating that wealth going into retirement. And obviously there's a few checkpoints, um, and priorities along the way, Um, that you wanna reach. So

Speaker 1:
when structuring investments or portfolios, how it's just about keeping those overarching themes in mind of what was actually the priority for the client. So looking at your your younger client, you starting out, you ideally want to get your vehicles right. And then you would look at your underlying, um, asset allocation and you split between your compulsory funds being your retirement funds and and your voluntary and not falling into a trap or you're too heavily weighted,

Speaker 1:
um, to to either one. So what about the accumulation phase? Pre retirement? OK,

Speaker 0:
so you mentioned then post retirement. There will be a liquidity demand from from the client portfolio.

Speaker 0:
So then would an allocation to hedge funds then be appropriate for these clients considering certain constraints such as a liquidity constraint or, um, a AAA time horizon

Speaker 1:
constraint. So even though the objectives are a lot different, um, I find that hedge funds could work. Um, be it pre or post diamond.

Speaker 1:
Um, because it's it. It really does depend on how you structure it and to what extent you use it. So, um, for your in the pre retirement space, Like I said, we are looking at at more at your gain at your capital growth over a longer period.

Speaker 1:
Um, having exposure to a slightly more aggressive hedge fund can be, um, of benefit to the client, keeping in mind that it's also very much a diversify a, um, low correlation to the other type of funds that you would typically use a long, only equity or balance fund. So, um, there's Alpha. There's diversification,

Speaker 1:
and it it gives the clients with something different to look at and something different for us to talk about as well. Um, with client reviews, because it really is about the the conversation and really talking the client through that journey and having them buy into what you're actually, um, structuring for them, Um, in your post retirement space there, your your main concern. There is income, sustainable income

Speaker 1:
and keeping your longevity risk, um, in mind because we're we're living longer than than we than we want to. Sometimes and you really want to avoid that situation where you are outliving your funds, and there again, hedge funds can play a different type of role. You probably use it to a different extent with different type of hedge fund there. But there it really does aid in that smoothing, um, of returns. You're not getting that

Speaker 1:
typically what you see, it's lumpy returns, Um, really minimising that drawdown, um, and the volatility. So there's a lot more. It's a lot more predictable. And that's what you want. Post your time if you want predictable and you want as as safe as you can go while still getting inflation beat in return. Absolutely.

Speaker 0:
Thank you very much. A

Speaker 0:
for painting the picture there for us, Um, but then James take us through the the hedge fund that you manage at Attain Capital Management. And how would it be appropriate for these two very different clients? I mean, I think the first thing I would say is that our aim with our long short strategy at State Capital Management, is to outperform the market over time,

Speaker 0:
but to do so by taking on significantly less than market risk. So the long short strategy has a 14 year track record, of which our retail data liquidity Um Fund, which we launched in October last year, is a replica of that long short strategy. But over 14 years, the strategy has generated an annualised return of 17.2% per annum. Net of fees,

Speaker 0:
UH, which is about four points ahead of the market return over that 14 year period. But very importantly, we've done that by taking on significantly less than market risk. So the average exposure of the hedge fund over 14 years has been about 25% which is about a quarter of the market's exposure.

Speaker 0:
And that kind of drawdown protection characteristic that you spoke about is very evident. If you look at the top 10 biggest drawdowns over the 14 year track record, the strategy has significantly outperformed the market in nine out of the 10

Speaker 0:
and actually generated a positive return in six out of those 10 biggest monthly drawdowns. And in fact, if you look over the entire 14 years, the average return of the strategy in AJ AC down month is actually positive naught 140.8%.

Speaker 0:
So really, our focus is on that draw drawdown protection and managing that risk, but also outperforming the market over time. And I think the point I'm trying to illustrate here is that the strategy that we run is not an aggressive strategy. It's a strategy very much aimed at, you know, generating uh, market beating returns, but with a strong focus on that downside risk. So maybe getting back to the question and how it might be appropriate for which clients? I think. Given those characteristics,

Speaker 0:
Um, this would be particularly interesting. Interesting for a client, Um, who is at or in retirement, who is looking to grow or or, um, get get returns on their wealth over time, but really manage that drawdown? The the strategy has a much lower than market volatility. It's comparable to something like a balanced fund. Um, but with a much lower um uh, correlation to the J S E.

Speaker 0:
And so you know, if you think about a strategy that can generate returns with much lower volatility and with much higher drawdown protection that really addresses that you know key sequencing risk for someone who is aiming to draw down on a on A on capital over time, and to avoid that kind of having to draw down on capital in a draw down, um, in a drawdown in a market.

Speaker 0:
Um, so so certainly, I think very interesting for someone in that phase of life for someone who who is less sensitive to volatility with a much longer time horizon, like the the younger client that you that you first spoke to. What I would say is that it can certainly given the strong out performance of the market. It can certainly be a very interesting building block or replacement for the equity piece in that portfolio. But in fact, if you look

Speaker 0:
over the 14 years that client would have done better by investing in our long only strategy, which is just a carve out of the long book of our hedge fund, and he would have outperformed, um, he would have done better by about 2% points per annum, so generating about 19% points annualised over that 14 years. But obviously without the same downside, um, you know, risk mitigation characteristics that you would get in a hedge fund.

Speaker 0:
What I would say, though, is that if you look at the market environment that we've been in certainly for the last decade with, you know, lots of global liquidity and a bear market, a bull market and stocks. I would say that perhaps the next 10 years is not necessarily going to look like the last 10 years. And certainly if we entered a period where of an extended bear market or even a sideways market, I would expect a hedge fund to significantly outperform.

Speaker 0:
Um, a long only strategy in that scenario. Yeah, absolutely thanks, James. So it seems as though you know, hedge funds. You've got this broader set of, um, tools from which to to earn Alpha. Then Erin. Why would clients be hesitant of allocating to hedge funds? I know that there's in the US. There have been a few hedge funds that have blown up from excessive risk taking, But is that the only reason why clients would be hesitant?

Speaker 1:
I think a lot of it is driven by by perception, and,

Speaker 1:
um, it really does depend who your who your clients are listening to, who they're speaking to, but also it largely comes down to their personality. So naturally, some, um, clients would be more risk averse others, um, would be open to taking a bit more risk. But I think once a client has a better understanding of something, they can really make a more informed decision. And I think that's

Speaker 1:
that's the role of the advisors myself. Um, To without needing AC, FA um qualification to be able to explain to a client in A, in a way that they understand exactly what they're buying into because I think it's, um, partly because of that miseducation and seeing headlines hearing stories of what happened, um, in the US with other clients. Once you actually know what you're getting into,

Speaker 1:
um, the client can make a much more informed decision. There is a perception that the hedge funds are these extremely volatile, risky vehicles, and it's actually the it's the opposite. Um, but And once you can have that conversation with the client

Speaker 1:
and actually show that to them, then then the conversation is more open because then you can start there a boarding block starting to be incorporated, and the client is a lot more a lot more comfortable and not having sleepless nights because they have some exposure to wedge fund. I think maybe if I just add on to what Aaron said there around, you know, uh, around hedge funds. And why certain,

Speaker 1:
particularly at retail investors, who would feel that hedge funds are a little bit more risky? There's always been this perception that it's opaque in what strategies are actually being utilised within hedge funds. You know? I mean, the you know, regulation hasn't really been developed a lot around hedge funds, um, specifically for retail clients over the years, and that is changing. Obviously, it's taken some time to get there.

Speaker 1:
Um, but hedge funds have always had this perception of not really being transparent about what's under the hood of their fund. And, uh, you know, some retail investors not necessarily knowing what's going on there. There's obviously a lot more complex. As you mentioned, there's a lot more tools available, so there's more complex stuff

Speaker 1:
structures that can actually be implemented in a hedge fund. Um, which might also add to that, uh, that

Speaker 0:
misunderstanding. Absolutely. So then look, um, to continue your points and the solutions that you offer at LA Invest, where and when would a hedge fund such as the hedge fund that stay in Capital Management.

Speaker 0:
Where would this fit into some of the solutions that you that you make use

Speaker 1:
of? So I mean at at Glacier Investor. I mean, we specifically try to build solutions that fit the whole investment life journey of an investor. And Aaron is actually, um, you know, flesh it out quite nicely. There is both a retirement phase where you are focused on wealth accumulation.

Speaker 1:
And then there's obviously the post retirement phase where you are looking to draw income from your portfolio. Now a hedge fund in particular, we believe, has a very unique characteristic about it. And that's what we call an asymmetrically return profile. Most of the time, even you are, you know, you come across good hedge fund managers. They are able to capture less of the downside

Speaker 1:
and still capture on the on the upside when markets are running. As, uh, James has mentioned, uh, in what the hedge fund does in their long short strategy. And and that's effectively something that's quite powerful for an investor, um, throughout their life cycle. So we actually look to incorporate hedge funds both pre retirement and post retirement, because it really caters to that asymmetric return profile. We want less of the bad. More of the good.

Speaker 0:
Absolutely. Don't we all?

Speaker 0:
Um but now tell me, would there be any regulation that perhaps is constraining the uptake of of hedge funds by the F

Speaker 1:
n? Yeah, certainly. I mean, uh, if we just look at, uh, Regulation 28. I mean, we know that for the longest time ever, you know, uh, hedge fund allocations that are available for Preti roughly only been about 10%. Um, and then also, we know that, you know, there's been a little bit of a constraint in how, um, you know, lists go about administering hedge funds within client portfolios.

Speaker 1:
Um, especially when it comes to the issue around certain advisors being able to write hedge fund business because we know that, you know, hedge funds can be used across various products. However, if you look at something like an investment plan which is a discretionary product,

Speaker 1:
you need a particular type of licence as an advisor to be able to include a hedge fund in that and then also you have the constraint that, you know, lists need to be able to monitor advisers that are using their platform as to does this. You know this advisor Have the the regulatory,

Speaker 1:
um, you know, qualification to be able to write hedge fund business. And if that end client moves from that, you know that advisor to another, How do we track this? And that's been a bit of a constraint that we've seen, um, over the last few years that is being resolved. A lot of the platforms are coming to the fore and being a lot more front footed in how they can actually administer hedge funds within, um, in, uh, you know, both pre and post retirement products.

Speaker 0:
So then what would the practicalities be around surrounding the use of hedge funds, particularly in in certain solutions? How Where would you implement a high risk, Um, hedge fund or a lower risk hedge fund? And would they be appropriate? Um, for all the solutions,

Speaker 1:
um, so if you actually look at

Speaker 1:
what's what's the the lay of the land that's been fleshed out by a CS a. So c SAS come out with various categorizations now for hedge funds and that being, you know, focusing on fixed income hedge funds, equity focus, hedge funds and then also your, um uh, your differentiated strategies. Um, particularly if we look at, let's say, the equity space within the equity space. We come across funds like market neutral funds and then also long short funds. Now, what we found is that

Speaker 1:
market neutral funds tend to have a lot less volatility relative to the equity market and even the bond market. So you've got a fund structure over here which has a very low net equity exposure Where, um, you know, roughly the exposure is almost zero to correlation to what's happening in the market because it's net Uh uh, market neutral. So to say, um, not necessarily the same case with the long short uh uh, hedge fund, which has a long bi, which will take on some of the characteristics of the overall equity market.

Speaker 1:
Now what we found is that market neutral funds are a little bit more appropriate for clients that are sensitive to volatility, given that the fact that they have a lower volatility profile over time and that in our opinion would be quite useful for, um, clients that are not looking to, um, experience that volatility in their profile, especially when they're drawing income. So quite appropriate for AAA. You know, an investor that's looking to draw income in post retirement.

Speaker 1:
Not to say that you you wouldn't necessarily want to use a long short equity fund, because what we've also noticed is that, as Aaron has mentioned, there is a longevity risk. Long short, um, funds tend to also outperform quite handsomely, given that they have a higher equity exposure than, let's say, a market neutral, you still need to keep in. Uh, you know, keep into account that there is still a return objective that investors need to reach, especially if they haven't saved enough, uh, for retirement.

Speaker 0:
So, James, with all of the points that have been mentioned now, how would your fund then be appropriate for pre retirees and post retirees and specifically, the client scenarios that were highlighted and then again for for D. F MS? Sure. So I mean, as I mentioned earlier, our strategy is very much, uh, um focused on that downside risk. But, you know, we've been able to outperform equity markets over time, so what you're getting is a an equity plus return. But with that downside risk mitigation.

Speaker 0:
Um and, you know, addressing Luke's point, you know, So we've We've run the strategy for 14 years with a a beta adjusted net exposure of about 25%. So that's it's not market neutral. We run a long biassed fund, but it's it's has a it runs with a, you know, relatively low net equity exposure on a beta adjusted basis, and that comes through really in the much lower volatility characteristics and much lower correlation to the market characteristics.

Speaker 0:
Um, so certainly, you know, for an investor who is looking to to actually, you know, benefit from equity plus returns over time. But manage that downside, you know, it really is, um, you know something that I think would be of great interest to that kind of investor. And I think that we certainly are seeing a lot more interest, Um, from retail investors in hedge funds, generally to Aaron and Luke's Point, you know. So you know, we launched our daily liquidity hedge fund in October of last year,

Speaker 0:
and as I mentioned, that's a It replicates the the strategy of our longest running long short hedge fund. And, you know, since October last year, that strategy has grown from from basically a standing start to just shy of 100 million rand to date. So there is certainly investor interest in the, you know, in the strategies, Um, and in hedge funds, um and, yeah, we've been We've certainly been been seeing that. OK,

Speaker 1:
I think maybe just to add on to what James has mentioned, I think you know, uh, you know, it's one thing having a track record, Uh, that's in a qualified structure. I think one of the things that we as d f MS have been looking at is how do these hedge fund managers actually manage to retail hedge funds? Because there is a lot more cash flows that's involved, you know, money coming onto the list, then being invested in the fund, then money being drawn for income needs. I do think that that doesn't have an impact on, uh, on the you know, that

Speaker 1:
return profile that you would get in the retail product relative to what we would call a qualified investment strategy where you're not necessarily having all that liquidity moving in and out of the fund. And maybe James, that is something you can maybe, um flesh out for us here. How do you guys go about that? Liquidity? Um, requirements for retail investors?

Speaker 0:
Certainly. So. I mean, the first thing I'd say is that as a long short strategy, we obviously are along the market and short the market.

Speaker 0:
Um, but, you know, when you short stocks, you actually generate cash in the in the in the fund. Right. So you short a stock, you you receive cash for that. And you actually so we carry, um, around 30% of net asset value in cash at any one

Speaker 0:
point in time and the fund. So in terms of actual liquidity of the fund itself, there is. You know, there's a significant amount of cash holding at any point in time just because of the nature of how you are long and short equities in the cash generation characteristics of that,

Speaker 0:
Um I mean, another thing that is obviously very important in in managing these strategies is the liquidity of the investment positions that you have. And that's something that you know, that we monitor very, very closely and the the the strategy that we've done in the qu F in our Qu F Fund with that 14 year track record is being replicated

Speaker 0:
in this daily liquidity riff. And there's there's really from a liquidity profile perspective. It's something we we manage very closely. But really, there's no problem with being able to facilitate that daily liquidity. Given that we are investing in typically very liquid, um, you know, as J C listed cash equities.

Speaker 0:
So then, when you approach a hedge fund manager, are there specific questions that you might be intrigued in when considering use of the hedge fund in your solutions?

Speaker 1:
Most certainly. I guess it really would centre around portfolio construction because we do know that hedge funds have a broader toolkit in what they can utilise to bring out a specific investment offering. And for us, it's around, Uh, you know, capital preservation. What tools do you utilise to try and protect? On the downside? Because most hedge fund managers, that's the first thing that they say they look to be, uh, capital, Uh, protectors,

Speaker 1:
Um, and then also at the same time, how do you also amplify your gains? Because we know that hedge funds can also utilise leverage within their portfolio. And how successful are they in being able to do that and maybe also take, you know, um,

Speaker 1:
advantage of certain things that happen in the market market movements that, uh, you know, uh, allow for stuff like special opportunities. Sometimes there's mergers and acquisitions that happen. How are you able to latch on to those kinds of opportunities? And those are the things that we really want to get out of a hedge fund manager to identify. Who are the truly skillful managers out there?

Speaker 0:
Yeah, James can elaborate and perhaps just touch on a merger and acquisition Or, uh, sure

Speaker 0:
that you that you made use of sure. No, absolutely. I mean so. As as Luke mentioned. Certainly, hedge funds, in a broad sense, have a much bigger tool kit to take advantage of of market opportunities. So you mentioned, you know, options and leverage. These are certainly all tools that are available to hedge funds in terms of our specific strategy. What I would say is that we're we're very much focused on generating offer on both the long side of the book and on the short side of the book. So,

Speaker 0:
um, over the 14 year track record, we've generated around 16% annualised Alpha on the short side of our hedge fund book. And that's mainly by focusing, uh, on bringing our forensic accounting skills to bear on identifying companies that are potentially going to be missing earnings. Um, and that that this is not well understood by the market.

Speaker 0:
And so, you know, we're very much focused on generating off on the long side and the short side, and obviously through that, you get it. You get exposure to both the leverage that you can get within a portfolio. Um, although what I would say is that you know, we've averaged over the 14 years

Speaker 0:
Ross exposure in our hedge fund of around 100 and 35%. And so you would know that the limits within, um, within retail hedge funds are set at 200%. So this is well within the limits. And in terms of hedge funds, it's actually a very modest amount of leverage that we've been running.

Speaker 0:
Um, but still, over that time, we've been able to, you know, to really utilise that toolkit to take advantage of Gene that alpha generation on the longs and the shorts in terms of, um, special situations. This is something that we are very, very focused on. So we have a significant amount of corporate finance

Speaker 0:
skills in house, um, which we really bring to bear on really trying to take advantage of those market dislocations that you often find when you have mergers and acquisitions or unbundling or restructurings or liquidations that that that occur on the J. S. E.

Speaker 0:
And, um, you know, over the last few years, we've been able to take, uh, advantage of a number of these. A couple of examples would be something like, uh, R and B holdings, which, you know, unbundled its, uh, first rand stake, leaving essentially a, um, you know, a cash shell, uh, with some some legacy property assets. So what this did is, you know, following the unbundling, it essentially became an orphan stock and then sold down below the cash value on

Speaker 0:
on its balance sheet. You know, even though management had articulated a plan to actually monetize those assets over time and distribute that back to shareholders, so we were actually able to establish a position in the in the stock, you know, well below cash value and then benefit as management unlock. Unlock that value through, you know, selling those properties over time. And this is just one example of, you know, the kind of situation that arises when you have market

Speaker 0:
technicals or technical selling pressure, you know, from, um, from index funds or the like who are selling things without without reference to the underlying fundamentals. So that would be a good example, something like the P s G merger arbitrage that we took advantage of during the course of last year and were able to generate just shy of 200% internal rate of return on capital invested for our investors. And we were able to do that by basically

Speaker 0:
buying the P S G stock long and then sorting out the underlying components that were gonna be unbundled in a hedging ratio and really focusing that exposure on that spread closing. Um, you know, on the deal on the deal closure. So these are the kinds of opportunities that you can really take advantage of when you can, you know both. Gosh, uh, go short and long, um, within a within a portfolio. And then what's fantastic about these opportunities? Just the last point

Speaker 0:
is that you're able to generate Alpha that is very uncorrelated to the market. So you're able to generate these returns with very limited directional market risk. And that's really what we're seeking to do. Absolutely. So I think that was quite a comprehensive explanation about, um how they, um, employ some of those tools in in the hedge fund. But yeah, I wanna thank you all for, uh, helping unpack the role of hedge funds and client client solutions. Thank you very much.