Access alternatives
- 1. December 2017 “Don’t put all your eggs in one basket” – a simple concept that the majority of us learnt through various avenues of life long before we understood much about asset management, and yet the truth it contains remains core to the investment industry. Ironically investors far too often ignore this simple truth. The rise and fall of bitcoin saw a large number of people placing far too many of their eggs in a new and untested basket – the fear of missing out or the hope of catching up resulted in many losing far more than they could stomach. On the other hand, some investors have been using the same two baskets – equity and bonds – for the majority of their life and will most likely not see the need for any additional baskets until a very full one suddenly hits the ground. Concentration & Correlation This analogy effectively showcases the concept of concentration – the more money invested in one company or asset class, the more you stand to lose if something goes very wrong. Occasionally even a successful businessman with a lifetime of experience falls victim to a perfect storm as a result of being too concentrated. The destruction of Christo Wiese’s wealth amidst the Steinhoff collapse is a perfect example. Concentration is however not an investor’s only concern when constructing an investment portfolio. Correlation is equally important. The magnitude of the positive correlation between assets is the extent to which their prices move in the same direction. It could be considered as two baskets carried in one hand; if one falls, there is a greater chance that the second is also on its way to the ground. A more desirable quality is negative correlation between assets. An example of this can be seen in times of political unrest or economic uncertainty, where stocks typically lose value due to uncertain profit prospects, and the price of gold increases as it is seen as a way to store wealth outside of the financial system. In constructing a diversified portfolio, due care should be taken to ensure that an investor has sufficient exposure to assets that are negatively correlated. Such a portfolio is able to decrease the likelihood of not achieving the expected outcome without necessarily having to sacrifice the magnitude of the portfolios expected return. Access Alternatives Elmien Wagenaar & Kobus Jansen van Vuuren Regulation changes in the South African hedge fund industry has created a liquid, well-regulated environment in which all investors can gain access to the diversification benefits that comes with including an alternative component to a traditional portfolio.
- 2. December 2017 The Traditional Portfolio Traditional investors typically ensure that their expose to equity is diversified across different companies, sectors and geographic locations. Although this increases the certainty of generating a return in line with the expected return, even a well-diversified equity portfolio remains heavily exposed to the general direction of the market. For this reason, bonds are usually included as an additional asset class in these portfolios. The negative correlation between equity and bonds helps limit losses when equities are down. Apart from the likely, yet usually small allocation to cash as a liquid, low- risk, low-return component, traditional investors see equity and bonds as the full scope of their investable universe. Alternative Investments Outside the asset classes frequented by traditional investors lies a world of investment opportunity. Hedge Funds, private equity, real estate, agricultural commodities and derivative contracts are but a handful of the investable instruments presented as alternatives. These investments are considered alternative as a result of their returns being largely independent of traditional financial markets. One example is agricultural commodities which has its core dependencies on factors like weather conditions, stock piles and crop quality. Another would be private equity, the ownership of a few unlisted businesses, the value of which is not significantly affected by sentimental trading in the market. These instruments create opportunities to further diversify a traditional portfolio, although the inclusion of alternative investments is widely considered to be accessible only to high-net-worth individuals or institutional investors. The reasons for these investments being excluded from traditional portfolios and solutions catering for a wide array of investors is firstly that there is often a large initial capital commitment, as is the case particularly with private equity or real estate investments. Additionally, these investments are very illiquid making it unfavourable for the average investor that needs regular cash flows. The lack of regulation of some alternative instruments also leads to them being excluded from mainstream portfolios. Hedge Funds Historically hedge funds were avoided by the majority of investors for many of the same reasons - high minimum investment requirements in combination with the lack of regulation resulted in the hedge fund industry catering for a very niche market of investors. Since 2016 the majority of South African hedge funds have transitioned to be regulated under the Collective Investment Schemes Control Act (CISCA). Under the new regulation hedge funds are structured the same way as traditional unit trust funds and the products are overseen by the Financial Services Board. As a result, a full spectrum of hedge fund strategies is now available to investments of all sizes in a monthly (and in some cases daily) trading, well-regulated environment, while many of these strategies aim to provide the diversification benefits of an alternative investment. Short selling and well managed leverage are examples of strategies that only hedge fund managers are permitted to use under the CISCA, while the regulation provides sufficient investor protection
- 3. December 2017 Conclusion Access to alternatives is no longer only for the elite, the new well-regulated environment in which South African hedge funds operate has opened the doors to any investor. As a liquid investment with returns that are largely uncorrelated to traditional asset classes, hedge funds are able to be both a diversifying and return generating component in an investor’s portfolio. An investment in a fund of hedge funds diversifies exposure to alternatives across a number of expertly selected hedge funds, providing the investor with a suitable complement to their traditional portfolio. Disclaimer The RCIS Think Growth QI Hedge Fund is managed by THINK.CAPITAL Investment Management Proprietary Limited in terms of a discretionary mandate. THINK.CAPITAL is an authorised financial services provider (FSP 46714) in terms of the FAIS Act. This document has been compiled for information purposes only. It is provided in good faith and has been derived from sources believed to be reliable and accurate. No representation or warranty, express or implied, is made in relation to the accuracy or completeness of this information. It does not take into account the needs or circumstances of any person or constitute advice of any kind. It is not an offer to sell or an invitation to invest. Past investment performance is not a guarantee or indicative of future performance. Returns are subject to fluctuation and may be volatile. Returns are net of costs and for a particular fee class. Collective Investment Schemes are generally medium- to long-term investments. An investor may not get back the full amount invested. No responsibility or liability is accepted by THINK.CAPITAL, its subsidiaries and its associated companies and/or the directors, employees or agents of THINK.CAPITAL for any loss arising from the use of this information. It is the investor’s responsibility to inform him or herself of and comply with regulations and applicable laws in the relevant jurisdiction in which they operate. The RCIS THINK Growth QI Hedge Fund is a collective investment scheme regulated by the Financial Services Board.