In an environment where traditional investment methodologies have struggled to generate strong returns, the advantages of hedge funds should not be ignored in a well-balanced portfolio. Recent events and persistently challenging global economic conditions have meant that most diversified portfolios with exposure to numerous markets, industries, and asset classes have struggled to generate adequate returns.

One of the main goals of hedge funds is to generate absolute returns, which means generating positive returns regardless of overall market performance. Most established and reputable South African hedge funds have track records exceeding a decade or more. They are managed by experienced investment managers who employ various strategies and techniques to generate returns in bullish and bearish market conditions.

Investing in this alternative asset class continues to grow more mainstream locally and globally as investors continue their hunt for lower volatility, better returns, and capital preservation beyond traditional asset classes such as equities, fixed income, and bonds. Hedge Funds have gained popularity among investors in recent years due to their ability to provide consistent long-term performance while reducing overall portfolio risk.

So what is a hedge fund? A hedge fund is an investment class similar to a unit trust fund and governed by the same Collective Investment Scheme’s Control Act, but has broader discretion in terms of the types of investments the fund manager can pursue, and a more comprehensive set of tools that can be employed to generate returns and manage risk.

One of the basic components of hedge funds is the use of short selling. This is the practice of borrowing securities that are not currently owned by the fund and selling those securities today, with the expectation that the price will fall in the future. The fund aims to buy the securities back at a lower price than the price at which they were sold, return the borrowed shares to the lender, and profit from the difference. This strategy allows hedge funds to capitalize on market declines and potentially generate returns even when the overall market is falling.

Another common strategy employed by hedge funds is the use of “pair trades”. Pair trades involve buying one security and concurrently short selling another security, generally in the same sector, that is expected to perform differently. The expected divergence between the price of the “long” and that of the “short” typically takes place as a result of a correction in relative valuations, or fundamental outperformance of the long relative to the short. Pair trades can help hedge funds reduce overall portfolio risk by balancing potential losses in one security with gains in another without assuming any overall market exposure.

Hedge funds often attempt to construct portfolios that have a low correlation with the overall equity market. This means that the performance of these funds is not closely tied to the overall market’s performance, which can help reduce the risk for an investor’s overall investment portfolio. Investing in funds that have low or inverse market correlation reduces the volatility of the investor’s returns, thereby smoothing the return profile generated by an investment portfolio over time.

Peregrine Capital, South Africa’s longest-running hedge fund manager, has a suite of hedge funds that offer investors a variety of investment strategies based on their risk profile. The company manages just over R15bn of investor assets through its two local flagship hedge fund strategies, which are open to institutional and retail clients. Their Peregrine Capital High Growth Hedge Fund is the first fund in South Africa to achieve 100X an investor’s initial investment, so a million rand invested in the fund in February 2000 is worth more than R100 million now. Their Peregrine Capital Pure Hedge Fund has never had a negative year since its inception in July 1998.