What is a Hedge Fund

Clearing-up the Hedge Fund Haze

Most of us have heard of hedge funds - those mystical investment vehicles run by men in suits, living in New York and making millions every day. The reality is that they are often far less extravagant than movies and myth have made them out to be. The primary goal of a hedge fund is to preserve the capital invested. This is a far cry from the high risk, racy funds that come to mind when most of us think of hedge funds.

Hedge funds have been available to sophisticated investors (sometimes termed Qualified Investors) for some time in SA. Anchor Capital offers hedge funds to institutions and high net-worth individuals.

Unlike a collective investment scheme (unit trust), hedge funds are not currently regulated by the Financial Services Board (FSB) which has meant that advertising and selling hedge funds has been restricted. In April 2014, the Treasury and the FSB released draft legislation that proposes to change this and 2016 will see hedge funds offered via Collective Investment Scheme trust structures - in this way hedge funds will become regulated in much the same way unit trusts are regulated. Greater oversight and FSB regulation will be positive for the hedge fund industry in SA and should result in increased use of - and investment in - these attractive investment vehicles.

Glen Baker, the head of alternative investments at Anchor Capital, defines a hedge fund as "a portfolio where the fund manager can buy or sell assets and gain exposure via derivatives where appropriate. Mandates are wider than most traditional long only funds and leverage can be employed, but the focus is on capital preservation in the first instance and hedge funds should targets real rates of return over the medium term."

The variety of assets in which the fund can invest and ability to make use of complex investment strategies allows the fund manager to tailor a hedge fund to the individual needs and risk profile of the investor, often to a far greater extent than other fund structures (such as an equity portfolio).

The ability of hedge funds to make use of derivative instruments and more complex investment strategies is what differentiates them from unit trusts and other 'simpler' investment vehicles. The mandate of each hedge fund will set out the investment strategy and determine what the fund can and cannot do. Hedge funds such as the Anchor Long/Short Fund have the ability to short equities and utilise equity derivatives. The fund can also invest in currencies, equities, fixed income and debt.

In simple terms, a hedge fund is a structure that allows the investor to invest into a variety of assets (equities, cash, bonds, listed property etc.) and uses investment strategies to preserve the capital invested and achieve real returns (returns that are above inflation after fees). An important distinction between hedge funds and typical "long only" investment portfolios is that a hedge fund can make money out of falling share prices as well as rising share prices - this is due to the ability to "short" (i.e. sell shares they don't own) shares and hence profit by the subsequent price decline. This is why hedge funds have the ability to protect capital in falling markets. Price movements can also be "geared up" by employing leverage within the fund structure - in other words, R100 of investment value can gain exposure to more than R100 of assets, long or short.

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