The undeniable global macroeconomic step change warrants a re-think of portfolio construction for the next investment cycle. The regulation of hedge funds presents an additional tool previously not available to the retail investor that can act as a component of greater certainty in a portfolio cognisant of a VUCA world

1. July 2018
VUCA is an acronym, first used in 1987, to describe or reflect on the volatility, uncertainty,
complexity and ambiguity of general conditions and situations. More recently VUCA became
well known through its use by the American Military to describe extreme conditions of
modern warfare.
Access to alternative sources of return is no longer only for the elite. 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 Sector Conduct Authority. But hedge
fund strategies remain diverse and aim for various outcomes; different hedge funds are able to be
both a diversifying and return generating component in a portfolio. An investment in a fund of hedge
funds diversifies exposure across a number of expertly selected hedge funds and can provide the
investor with a suitable outcome to complement their traditional portfolio.
We investigate three areas, namely return, predictability of outcome and downside protection to
demonstrate the value that can be added through an alternative source of return. In order to conduct
this analysis, the after-fees fund of hedge fund track record of THINK.CAPITAL’s portfolio manager
is used as a representative Hedge Fund Solution*.
Introducing the hedge fund return profile
Each marker on the graph in Figure 1 represents the five-year annualised risk and return
characteristics of cash (STeFI Composite Index), bonds (All Bond Index) and equities (JSE All Share
Index TR) as asset classes and all the funds in three specific ASISA categories. The farther the
marker is to the left, the lower the risk (represented by volatility) and the higher the marker, the greater
the return generated over the period.
Reaching for Hedge Funds in a VUCA World
Elmien Wagenaar & Kobus Jansen van Vuuren

2. July 2018
The Hedge Fund Solution presents itself as a superior source of returns to
bonds while also outperforming the vast majority of ASISA General Equity and
ASISA Multi-Asset High Equity classified funds.
Over the past five years the Hedge Fund Solution provided investors with a return of 10.10% per
annum after all fees. This is less than a percent lower than the return of equities of 11.05% per annum
and 2.71% per annum higher than bonds, both at significantly lower risk.
Despite the slight underperformance of the equity index, the Hedge Fund Solution positioned itself
with a considerably better return outcome than the vast majority of its traditional counterparts across
both the General Equity and Multi-Asset High Equity categories. Although it also invests in equities
and bonds, an alternative return profile is created by using additional sources of return such as
shorting, that are only available to hedge funds. The ability to profit from a view that a specific
company is overvalued, increases the investment opportunities of a hedge fund. This can significantly
boost returns while reducing sensitivity to overall market movements at the same time. In this way,
the right combination of hedge funds and equities can complement each other well.
0%
5%
10%
15%
20%
25%
0% 5% 10% 15% 20% 25%
Returnpa
Risk pa
Figure 1: Annualised Risk & Return of a Hedge Fund Solution vs other
Asset Classes and Traditional Unit Trust Funds
1 Jul 2013 - 30 Jun 2018
ASISA Global General Equity ASISA General Equity ASISA MA High Equity
JSE All Share Index TR Hedge Fund Solution All Bond Index
STeFI Composite Index
Sources: THINK.CAPITAL, Realfin Fund Services, Morningstar
1

3. July 2018
The inclusion of the Hedge Fund Solution in a portfolio increases the likelihood
of investors achieving their expected returns, by reducing fluctuations in return.
It is inadequate to consider return alone when determining the potential and subsequent success of
an investment. There are inherent risks to every investment and one needs to question whether
returns generated are sufficient to justify the risks taken. Volatility aims to provide an indication of the
nature of returns by quantifying the frequency and severity with which the return of an investment
fluctuates.
Investigating historic return and volatility of asset classes allows a comparison to be made between
the characteristics one should expect from investments in each. The graphs in Figure 2 shows how
the manifested risk and return of the Hedge Fund Solution varied over any twelve-month period since
December 2003 by plotting each rolling twelve-month risk and return observed. The first graph
compares this variability to that of bonds and showcases that bonds have a greater variation in risk
suffered, but interestingly indicates that bond investors did not receive the additional compensation
one might expect when tolerating higher volatility. The graph shows that in the vast majority of cases
the Hedge Fund Solution was able to provide similar or far superior compensation for the severity of
return fluctuation endured by the investor.
The second of these graphs shows the contrasting characteristics of the Hedge Fund Solution and
equities. While the Hedge Fund Solution was able to provide clients with much more predictable
return and volatility across massively different market conditions since January 2003, the wildly
scattered equity markers speak to a significantly higher uncertainty of risk and return that is
characteristic of equities and will be experienced by its investors over time.
These graphs highlight the importance of correctly balancing one’s expectations from investments in
different asset classes and makes a strong case for the inclusion of hedge funds. It serves as a lower
risk component to a well-diversified portfolio, that brings additional sources of return, while also
exhibiting the ability to act as a solid generator of predictable returns.
2

4. July 2018
-20%
0%
20%
40%
60%
0% 5% 10% 15% 20% 25% 30%
Returnpa
Risk pa
Figure 2: Asset Class Risk-Profile Consistency
Rolling 12-month Risk & Returns: 31 Dec 2003 - 30 Jun 2018
Hedge Fund Solution
All Bond Index
-60%
-40%
-20%
0%
20%
40%
60%
80%
0% 5% 10% 15% 20% 25% 30%
Returnpa
Risk pa
Hedge Fund Solution
JSE All Share Index TR
Sources: THINK.CAPITAL, Realfin Fund Services, Morningstar

5. July 2018
The Hedge Fund Solution delivers strong downside protection during times of
stress.
During times of heightened equity volatility, the losses incurred by a portfolio exposed to equities can
be severe. This typically impacts the long-term prospects of the portfolio and often introduces
behavioural responses by client that can be to the further detriment of the investor’s portfolio. To this
end, downside protection during times of stress becomes vitally important.
Figure 3 displays the ten worst monthly losses of equities over the past five years, with the
corresponding returns of the Hedge Fund Solution. Apart from suffering a similar loss in January
2016, the Hedge Fund Solution was able to very effectively protect investors’ capital, and on multiple
occasions generated positive returns over these extreme downmarket months. The inclusion of the
Hedge Fund Solution would have improved portfolio robustness and buffered client experience.
Conclusion
Strong equity index returns and 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. However, currently many investors
find themselves in a position where they are forced to interrogate the reasonability of assuming that
the 2017 market experience will be repeated.
-5%
-4%
-3%
-2%
-1%
0%
1%
2%
3%
Mar
2018
May
2015
Nov
2015
Aug
2015
Jun
2017
May
2018
Feb
2017
Jun
2016
Jan
2016
Sep
2014
MonthlyReturn
Figure 3: Ten Worst JSE Monthly Losses
1 Jul 2013 - 30 Jun 2018
JSE All Share Index TR Hedge Fund Solution
3
Sources: THINK.CAPITAL, Realfin Fund Services, Morningstar

6. July 2018
The prospect of US interest rates normalising after ten years of compression has led to the aggressive
derating of many shares this year. Also, a possibly lengthy trade war between the US and China was
entered into with both countries imposing tariffs on imports. The global impact of this may be severe
and the market has tried to digest the result on profitability of many companies and local bonds have
displayed drawdowns too.
The undeniable global macroeconomic step change warrants a re-think of portfolio construction for
the next investment cycle. The regulation of hedge funds presents an additional tool previously not
available to the retail investor that can act as a component of greater certainty in a portfolio cognisant
of a VUCA world.
*Elmien Wagenaar (Analyst from 2002-2004, co-manager 2005, portfolio manager 2006 – present)
Referees
Disclaimer
The RCIS THINK Growth QI Hedge Fund and THINK Flexible Growth Retail Hedge Fund are 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 and THINK Flexible Growth Retail Hedge Fund are collective investment schemes regulated by the FSCA.