Why Combining Hedge Funds And Unit Trust Is So Beneficial

Combining Hedge Funds And Unit Trusts Inside A Single Portfolio Carriers Many Benefits For Our Investors

Our last article introduced our best view on balanced investing. We made mention of our ‘Core Combination’, which is currently the blend of a 75% Unit Trust and 25% Hedge Fund composition. However, what makes this combination so great? Retail Hedge Fund inclusions are not a new ball into the game within portfolios, however the inclusion of Qualified Hedge Funds into the mix are.

In an Interview with Sybrand Engelbrecht, we cover a couple of key understandings about these new portfolio developments and hopefully tackle some stigma and myths around Hedge Funds. In a brief summary, Sybrand captures the highlights of the content in the unit trust and hedge fund combination core. Here, we see that this combination provides investors with access to an amazing arsenal of investments inside a single portfolio. A combination of offshore and local equity, property, fixed income and credit, directional soft commodities and powerful alternative asset classes within the hedge fund space, along with technology driven algorithms all working together to generate excess return and a superior portfolio performance story to other balanced investing views.

The question was asked if there are specific benefits that this combination portfolio brings, that a standard portfolio could not bring. In short, the answer was a resounding ‘yes’. Two levels were highlighted, examining the assets being invested in, as well as the performance generated.

Let us begin by comparing the competitive advantage value-add which our combination core has to offer within the additional asset classes that become available for us to invest in for our clients.

This is a standard well diversified average balanced fund view that does not contain an apportioning to Hedge Funds.

Taking a deeper look into the additional asset classes which an investor gains inside our combination core portfolio, we saw roughly a 25% pull-out. This grants access to invest in alternative assets/strategies which are otherwise not available to standard unit trust portfolio investments. To name a few: Quantitative Directional Equity, Directional Equity, Directional Fixed Income & Credit, Equity Diversifiers as well as Soft Commodity Diversifiers.

These additional assets are not just fancy investment words attached to a new product for a ‘sales pitch’. They hold great weight and track record of back tested performance. In the Performance illustration below the Combination Core (in red) is tested against the average ASISA High Equity (Balanced Funds) in the industry (in yellow), our Hedge Fund of Funds portfolio (in orange) and the JSE(in grey).

The return journey speaks for itself:

It is great to see that the proof is in the pudding. Here we highlight 3 major events that moved markets to showcase our value-add within these portfolios. If we look back at a big event in the local environment, the dismissal of Nhlanhla Nene back in 2015, we saw markets pulling back sharply. However, the core strategy actually trended marginally higher, which clearly points to the uncorrelated nature of the construct to that of the broader market.

Looking at a more recent event and we are all aware of the devastating impact of the COVID-19 pandemic, here we can see that the core strategy fell as markets fell. Indicating that the combination does still get impacted by larger economic environments. However, noticeably, we can see that the extent to which the core strategy dropped significantly less than that of the overall market. In our team, it is our firm belief that we need to understand and manage the journey of our investors. We try and do this through adding another element to our investment strategy that enhance returns, by minimising the impact of declining markets. We refer to this as downside protection. By protecting capital when market correct or trend lower, clients remain invested and by definition get to participate in future upswings.

Myth Busting around Hedge Funds

Contrary to most people’s beliefs, Hedge Funds are not these overly foreign, ‘out-there’, risky investments.
Some of the words used inside these strategies like ‘derivatives’, ‘gearing’ or ‘leverage’ are not often referred to in the market place or media, but they are used in everyday transactions and have been available for a very long time. Historically, hedge funds are viewed as high risk instruments, that are “not far from gambling”. However, this is not true. Hedge funds make use of well-regulated instruments They can actually be quite conservative as well because of gearing, how many times gearing is applied inside a strategy, as well as asset classes being invested in. A unit trust, which most investors understand, is a pooled vehicle allowing you to invest in different asset classes like; equity, property, fixed income & credit and so forth. Hedge funds are simply another type of an investment pooling vehicle, like a unit trust. Unit Trusts, Retail Hedge Funds and Qualified Hedge Funds are all governed by the same Collective Investment Scheme legislation. Retail Hedge Funds and a Qualified Hedge Funds are pooled investment vehicles just like a Unit Trust.

“It is like picking a vehicle”

Lombard Barnard, portfolio manager at Fairtree Invest, likes to compare this to investors picking a vehicle for their journey.

It is kind of like having three vehicles in your garage, but you are only using the one and do not want to drive the others. However, all three are functional to drive and all three will get you to the end destination. However, they may each offer a different experience in the ride.

For example sake let us assume that the three cars in your garage are as follows; the one is a Corolla without power steering and aircon, the other a Corolla with power steering and aircon and the last is a Ferrari. Let us also say for this case, that we are investing in Equity and we need to pick an investment vehicle. (One of the cars in the garage).

The Corolla without power steering and aircon is like the Unit Trust. Your route is Cape Town to Mossel Bay. When arriving at Mossel Bay in your Corolla without power steering and aircon, you will get there at a certain time. The ride might have been hot and sweaty, the road a little bumpy and your arms a bit stiff. However, you arrive.

The Corolla with power steering and aircon is the Retail Hedge Fund. You also arrive at your destination, but this time you had power steering and aircon. The journey to Mossel Bay took you a similar amount of time to that of the Unit Trust, with less strain on your arms and body temperature. A smoother journey than the Unit Trust offering, a bit more comfort, but the same road travelled, arriving maybe a few minutes apart.

In investment language, with the Retail Hedge Fund and Unit Trust you will get more-or-less similar equity returns over your time horizon invested. The two Corolla’s have similar speed. However, one ride was smoother than the other, this is speaking to volatility/risk of the investment.

Now, Qualified Hedge Funds in the Equity space, like the Fairtree Assegai, is your Ferrari. You arrive at the destination a whole lot faster, with power steering and aircon, but the ride is not that comfortable. The low suspension profile of the car is built for speed, but makes for a bumpy ride. You experience exceptionally higher volatility throughout your journey on a month-to month basis. However, you reach your return destination a whole lot faster. This is not about making the ride more comfortable like the Corolla with power steering and aircon. The Ferrari is built for speed, not journey comfort. It takes the same highway to Mossel Bay, (investments in equity just like the Corolla’s), but is built for speed- capital growth – return generation. A Ferrari may be great for speed along this route, but a Ferrari is not bullet proof. Ferrari’s still get the odd puncture here and there.

If you are wanting a bullet proof Tank to journey off-road with, this would require using other assets in a Hedge Fund environment that are not solely for the purpose of Capital Growth, but rather Capital Preservation. These are the Qualified Hedge Funds that use other asset classes like Fixed Income & Credit etc and gearing. The tank, however, will not take the highway which your other vehicles took. It also will not get there as fast as the Ferrari. It is built for resilience and off-roading. It will arrive at your return destination slow and steady.

For the Qualified Hedge Funds like the Tank and the Ferrari – one really wants someone behind the wheel that understands the vehicle and knows how to drive it. This is why these structures are not casually available to the normal investor. The great thing about this combination portfolio which we have designed at Fairtree Invest, is that you now have access to the whole garage of vehicles as a ‘normal investor’, including the tank. Each of these vehicles in your garage have attributes that the other does not. So, together they assist your overall ride to the end destination equipping you for the journey ahead. There will be times in your journey that you want the speed of the Ferrari on the open road. Other times when the potholes come and you are driving through an unsafe area, the tank becomes your best friend. For the comfort and practicality of everyday life you want your Corollas. With our structure you own them all, best of bread in each vehicle type.

Let us manage your investment journey, we will drive and you can sit back and enjoy the ride.

Should you wish to speak to a wealth manager please contact us on clientservices@fairtreeinvest.com.

– Kheara Kroggel, Sybrand Engelbrecht & Lombard Barnard

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