Are (South African) hedge funds obsolete? The first step to answering the question is arguably to understand the context in which it is being asked...

1. June 2018
Are (South African) hedge funds obsolete?
The first step to answering the question is arguably to understand the context in which it is being
asked.
Over the past three years and seven months, a combination of South African hedge funds
represented by the since inception returns of the RCIS THINK Growth QI Hedge Fund (the Hedge
Fund portfolio) net of all fees delivered returns in excess of the majority of ASISA Multi Asset High
Equity and General Equity unit trust funds at a significantly lower volatility. At first glance, the
answer seems to be a simple no.
Investor recent experience
However, this period includes the 2017 calendar year, over which SA equities, as represented by
the JSE All Share Index TR (the Index), delivered a return of 20.95%, of which close to half (9.21%)
was generated by an increase in the Naspers share price. Being the company with the largest
weighting in the Index, the exceptional 71.80% increase in its share price was able to drown out
normal equity market volatility, especially to the downside.
-2%
0%
2%
4%
6%
8%
10%
12%
0% 5% 10% 15% 20% 25% 30%
Returnpa
Risk pa
Annualised Risk & Return: 1 Nov 2014 - 31 May 2018
ASISA General Equity ASISA MA High Equity
JSE All Share Index TR RCIS THINK Growth QI Hedge Fund
Are Hedge Funds Obsolete?
Elmien Wagenaar & Kobus Jansen van Vuuren

2. June 2018
The Hedge Fund portfolio delivered a 2017 return of 5.91% by being exposed to mandates where
managers took views that certain shares will increase in value, while others will decrease in value.
Although this strategy catered for a far wider set of market eventualities, only one eventuality
dominated – the significant outperformance of the largest company represented in the index. For
this year, in hindsight, the Hedge Fund portfolio seemed to be an unnecessary addition to a
portfolio.
However, to interrogate the reasonability of assuming that the 2017 market experience will be
repeated, the graph below shows the structure of JSE returns since 2000 by viewing the percentage
of daily returns per calendar year that were small (between -0.5% and +0.5%) and large (down
more than -0.5% or up more than +0.5%).
2017 stands out in relation to all other years with the highest occurrence of small daily moves, and
lowest occurrences of large negative moves.
Investor response
The uncharacteristically mild volatility experienced during 2017 seemingly removed the usual
reminder of the ever-present equity market risk and thus diminished the perceived need for an
alternative source of return able to mitigate this risk. This arguably comes at exactly the wrong time,
with compelling macroeconomic and statistical evidence suggesting that the contributors to the
2017 equity returns are unlikely to repeat their performance. In December 2017 the US Federal
Reserve also gave strong guidance that they are moving into a hiking cycle after a decade of
artificially low interest rates implemented to support the economy post the 2008 crisis.
Subsequently, year-to-date market movements have confirmed expectations of a reversion in
market volatility. In the first quarter of 2018 the Index incurred a loss of -5.97%, this was followed
by an increase of +5.37% and drawdown of -3.48% in the subsequent two months.
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
Frequency of JSE Price moves per Calendar Year
1 Jan 2000 to 31 May 2018
Small Daily Price Moves Large Daily Price Down-moves Large Daily Price Up-moves

3. June 2018
Yet, during this period investors have seemingly based their investment decisions on 2017 in
isolation. The Association for Savings & Investments SA (ASISA), in their May 2018 report on
collective investment scheme flows during the first three months of 2018 indicates a rush to high
equity products post December 2017.
“SA Multi Asset High Equity portfolios attracted strong net inflows of R9.7 billion. SA
General Equity portfolios were also popular with investors, attracting the second highest
net inflows for the quarter of R4.4 billion. South African (SA) Interest Bearing Variable
Term portfolios recorded net outflows of R4.4 billion and Money Market portfolios were
the quarter’s biggest losers with net outflows of R9 billion.” 1
Is this a South Africa - specific question?
Evidently not, as in the June 2018 edition of the Investment & Pensions Europe Magazine, similar
discussions emerge.
In an article named “Time for new alpha ideas” the necessity for recognizing a step change after a
decade long surge in equity markets is noted.
“Oxley has the view that while hedge fund returns have seemed mediocre in the recent
past relative to equity markets, what they aim to offer is different. It is diversification with
attractive risk-adjusted returns that investors should look to hedge funds for, not for
maximising higher but riskier returns.
This may seem to many like just an excuse for an industry with a poor record for returns
relative to fees. But the argument that the future is likely to look different from the past
with low bond returns and more volatile equity markets does give rise to a requirement
for non-correlated assets with equity type returns.” 2
The role of hedge funds in the next cycle is reiterated in a second article, “What future for long/short
equity?”.
“Investors suspect the market could be hitting the top of the equity cycle, so hedge funds
are starting to make a comeback with a role of diversifier/portfolio protection.
“Over the last few years, in an environment characterised by low interest rates,
compressed risk premia and flushed with liquidity seeking yield and flowing into ETF and
passive funds, fundamental stock picking has not always been rewarded,” says Daniela
Doria, principal at Mercer in London.
“We believe that portfolios dominated by traditional beta offer a relatively unattractive
risk/return trade-off on a forward-looking basis. The exceptional returns of the past eight
years are unlikely to be repeated and there is a scarcity of ‘easy beta’ to be harvested,”
Doria adds.” 3

4. June 2018
Conclusion
Strategies such as shorting, that distinguish hedge funds form traditional unit trust funds, create the
opportunity to benefit from a view that a certain share prices will fall. Hedge funds can only become
structurally obsolete if some market mechanism prevents, into perpetuity, the share prices of
companies with weak business models, weak balance sheets and weak governance to fall.
Although the heightened liquidity due to central bank intervention was to some extent such a
mechanism for a prolonged period, there is strong evidence that it is not a perpetual one.
The recent lull in hedge fund returns occurred in an environment where risk taking was rewarded
and protection showed to be unnecessary and detracting. In spite of the recent underperformance,
the longer-term value remains intact with a demonstrable outperformance of high equity products.
Adding to this, is the undeniable global macroeconomic step change that warrants a re-think of
portfolio construction for the next investment cycle. Hedge funds, that can better benefit from a
dispersion of returns, should therefore be considered.
References
1
https://www.asisa.org.za/media-release/tough-first-quarter-local-collective-investment-schemes/
2
https://www.ipe.com/investment/asset-class-reports/hedge-funds/time-for-new-alpha-ideas/10024991.article
3
https://www.ipe.com/investment/asset-class-reports/hedge-funds/what-future-for-long/short-equity/10024993.article
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.