Hedge Funds 101: What They Are, How They Work and Some of the Best Performing Hedge Funds

Last Updated on 13/08/2024 by Carl-Peter Lehmann

In recent years, hedge funds have been gaining traction among South African investors, evolving from niche investment vehicles to integral components of sophisticated portfolios. Unlike traditional long-only unit trust funds, which are limited to investing in assets they believe will rise in value, hedge funds have a broader array of tools at their disposal. This flexibility allows them to implement a variety of strategies designed to generate returns in both rising and falling markets. As a result, hedge funds are increasingly being used in portfolio construction to achieve diversification, manage risk, and potentially enhance returns. In this piece we will therefore explore hedge funds in greater depth and look at some of the best hedge funds and top performing hedge funds in South Africa currently.

Hedge Funds; Best Hedge Funds; Top Performing Hedge Funds

Table of Contents

What is a Hedge Fund?

Hedge funds are pooled investment vehicles that employ a wide range of strategies to generate active returns for their investors. They differ from unit trusts primarily in their investment flexibility. Hedge funds can invest in a diverse array of assets, including stocks, bonds, commodities, currencies, and derivatives. This flexibility allows them to pursue strategies that are not accessible to traditional fund managers, such as short selling, leverage, and derivatives trading.

Historically, hedge funds were available only to Qualified Investors (min investment of R1 million) due to the higher risks associated with their strategies. However, in recent years hedge funds have also been made available to retail investors making them much more accessible. Ultimately, these funds offer something different to traditional unit trusts/ETFs via the potential for higher returns and the ability to hedge against market downturns. But if they make bad calls or adopt particularly aggressive strategies like leverage, they can also blow up spectacularly, so they are not for everyone.

Types of Funds and Strategies

Hedge funds are known for their diverse investment strategies, each tailored to exploit different market opportunities. Below are some of the most common types:

Equity Hedge: These funds invest in equities, using a combination of long and short positions to capitalize on both rising and falling stock prices. The goal is to identify mispriced stocks and profit from their price movements, often employing leverage to amplify returns.

Global Macro: These funds take a big-picture approach, making investment decisions based on global economic trends, political events, and macroeconomic indicators. They might invest across various asset classes, including currencies, commodities, and interest rates, aiming to profit from significant economic shifts.

Event-Driven: Event-driven hedge funds focus on exploiting opportunities arising from specific corporate events such as mergers, acquisitions, bankruptcies, or restructurings. The fund managers analyze the potential impact of these events on the companies involved and invest accordingly.

Relative Value: This strategy involves exploiting pricing discrepancies between related securities. Relative value funds often trade in pairs, taking long positions in undervalued assets and short positions in overvalued ones, seeking to profit from the convergence of their values.

Examples of Famous Global Hedge Funds and Their Managers

The hedge fund industry has produced some of the most successful and influential investors in the world. Here are a few notable examples:

Bridgewater Associates (Ray Dalio): Bridgewater is known for its macroeconomic strategy, analyzing global trends to inform its investment decisions. Ray Dalio, the founder, is considered one of the most influential figures in finance, with his principles-driven approach to investing. Historically, this has been the biggest hedge fund in the world with AUM of about USD 120 billion.

Renaissance Technologies (Jim Simons): Renaissance Technologies is a pioneer in quantitative investing, using complex mathematical models and algorithms to predict market movements. Jim Simons, a former mathematician and founder of the firm, earned legendary status for his consistent returns, with their Medallion fund experiencing a 30-year period where it achieved 66% p.a. annualised returns (before fees); 39% p.a. after fees. No, that is not a typo!

Citadel (Ken Griffin): Citadel operates across multiple asset classes, including equities, fixed income, and commodities. Ken Griffin, the founder, is known for his risk management skills and the firm’s diversified approach to investing.

Retail Hedge Funds vs. Qualifying Hedge Funds

In South Africa, hedge funds are classified into two main categories: Qualifying Hedge Funds (QIHFs) and Retail Hedge Funds (RHFs). Qualifying Hedge Funds are typically aimed at professional investors, such as institutions or high-net-worth individuals, and they have much higher investment thresholds—often exceeding R1 million. These funds are designed to cater to sophisticated investors who have the knowledge and financial capacity to manage the higher risks associated with these investment vehicles.

However, to make them more accessible to everyday investors, Retail Hedge Funds were introduced. These funds are subject to stricter regulatory oversight and lower minimum investment thresholds, making them more accessible to retail investors who may not have the large sums typically required for QIHFs. RHFs still offer the potential benefits of hedge fund investing, such as diversification and alternative strategies, but they are structured to be less risky and more transparent, aligning with the needs of the general public.

Who Are The Best Hedge Funds and Amongst The Top Performing Hedge Funds in South Africa?

The South African hedge fund landscape has seen impressive performances from a select group of funds over the last 5 and 10 years (a couple have amazing 20+ year track records). Collating data on the best hedge funds and top performing hedge funds in South Africa isn’t quite as easy as it is for unit trust funds so this many not be a perfect comparison – but it provides a starting point nonetheless. We have used Morningstar and data from fund factsheets in our analysis. The chart highlights the following top performers:

Best Performing Hedge Funds; Top Performing Hedge Funds in South Africa
Some of the Top Hedge Funds in South Africa

1.) Fairtree Wild Fig Multi Strategy FR QI HF

  • 5-Year Annualized Return: 25.19%
  • 10-Year Annualized Return: 17.08%

This QIHF has shown exceptional performance since its launch in 2010, making it one of the best funds available in the market. Its return since inception has been 21% p.a. making it what appears to be the top performing hedge fund over this period. Amazingly this fund has also not had a single negative year of returns since launch. A retail version of this fund was also launched within the last couple of years, making it more accessible to everday investors.

2.) Amplify Managed Equity Retail HF

  • 5-Year Annualized Return: 18.57%
  • 10-Year Annualized Return: 15.78%

An aggressive long/short equity hedge fund, this fund has also delivered strong returns since inception, comfortably outperforming the ALSI.

3.) AG Capital Rainbow FR Retail HF

  • 5-Year Annualized Return: 18.7%

Another retail hedge fund, AG Capital Rainbow, stands out for its robust 5-year performance, but it doesn’t yet have a 10-year track record.

4.) 36One Absolute Alpha Retail HF

  • 5-Year Annualized Return: 15.38%

Known for its focus on absolute returns, the 36One Absolute Alpha HF has delivered consistent performance since inception in 2018 (16.71% p.a.), but is currently unfortunately closed to new investors. Amazingly, the level of risk of the fund as measured via standard deviation is only 4.54% p.a., which is about one quarter that of the ALSI at 17.54% p.a. over the same time frame (while achieving 50% better returns).

5.) Peregrine Capital High Growth QI HF

  • 5-Year Annualized Return: 13.28%
  • 10-Year Annualized Return: 14.16%

Probably the most famous hedge fund in South Africa (adopts a multi-strategy or multi-asset approach) with a track record that dates back over 20 years to 2000, it has delivered annualised returns of 23% since inception which is a cumulative return of around 16,000%. For context that means a R1 million investment compounded over 20 years has turned into about R95 million. It has only delivered 2 years of negative returns in the 24 years it has been going which is also remarkable. A retail version of the fund was launched in 2019.

Further Reading: Comparing the Best SA Equity Funds in South Africa

It’s worth noting too that some of the best hedge fund managers also run some of the best long only unit trust funds in South Africa which isn’t surprising because they will have a broader viewpoint when looking at markets and investment opportunities. Fairtree for example have been one of the best equity fund managers in SA for a long time and also run one of the best balanced funds in the country. 36One also have amongst the best SA equity unit trust funds going.

Now Read: Looking At the Best Global Equity Funds in South Africa

High Fees: A Consideration for Investors

One of the potential downsides of investing in these funds is the fee structure, which can be considerably higher than that of traditional investment funds. Hedge funds typically charge a management fee and a performance fee. The management fee is usually around 1% to 2% of assets under management, which is paid regardless of the fund’s performance. The performance fee, often referred to as the “2 and 20” model, can be as high as 20% of the fund’s profits, and it is only charged when the fund exceeds a certain benchmark or high-water mark.

These fees are designed to incentivize the fund managers to achieve high returns, but they can also significantly eat into investors’ profits, particularly in years where performance is mediocre. It’s important for investors to carefully consider these costs and weigh them against the potential returns when deciding whether to include hedge funds in their portfolios. For those investing in Retail Hedge Funds, the fees may be more moderate, but they still remain a key factor in the overall cost of investment.

While all the returns on the hedge fund performances above are net of fees – just to give you a idea of some of the fees via their TICs (total investment charges) – Fairtree’s is 8%, Amplify’s is a more modest 2.5%, Peregrine’s is over 6%. So as long as they keep delivering, all is well, but of course it becomes problematic if that ever changes.

The Value of Blending Hedge Funds into Investment Portfolios

Incorporating hedge funds into a broader investment portfolio can offer several benefits, particularly from a risk/return perspective. And due to the relatively poor performance of balanced funds in South Africa over the last decade, hedge funds are increasingly being blended into retirement funds (hedge funds are allowed a 10% allocation in terms of Reg 28) and living annuity portfolios.

Diversification: Hedge funds often employ strategies that are uncorrelated with traditional asset classes like equities and bonds. This means they can provide diversification, reducing overall portfolio volatility.

Risk Management: Certain hedge fund strategies, such as long/short equity or market neutral, are designed to mitigate market risk. These funds can act as a hedge against downturns in the broader market, preserving capital in adverse conditions.

Enhanced Returns: While hedge funds carry higher risks, they also offer the potential for higher returns. For investors seeking to boost their portfolio’s performance, hedge funds can be an attractive option, particularly when traditional markets are underperforming.

As an example looking at the image below – a moderately aggressive strategy as represented by a typical balanced fund – shows that adding a 10% hedge fund allocation increases the return over the period from 8.05% p.a. to 8.40% p.a., while reducing risk as measured via volatility from 10.03% to 9.46%. And for more agggressive mandates (not constrained by Reg 28), those benefits can be even greater.

The value of blending hedge funds into investment portfolios as shown in various ASISA categories.

Closing Remarks

This comprehensive guide provides a detailed overview of hedge funds, their types, strategies, and their evolving role in South Africa’s investment landscape. It also discusses the nuances of retail versus qualifying hedge funds, fees associated with these investments, and how they can be integrated into broader portfolios. 

Picture of Carl-Peter Lehmann

Carl-Peter Lehmann

Carl-Peter is a Director and Partner at Henceforward. He is a CERTIFIED FINANCIAL PLANNER and Investment Professional with more than 20 years experience. Thinking about how to improve and optimize client investment portfolios is something he is extremely passionate about.

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