In a year when local equities lost 8.53% on a total return basis, all size categories of hedge funds delivered positive average returns for the 12-month period ending 31 December 2018 – highlighting the diversification benefits this asset class brings to investment portfolios.
The 15th annual Novare Hedge Funds Survey shares findings related to asset size, performance and fees for the year ending December 2018.
“Overall, hedge funds performed well relative to the market, despite a notable wider dispersion of returns. Hedge fund managers highlighted that the absence of high volatility in capital markets, coupled with regulatory changes, were key challenges faced by the industry during the period,” said Kagiso Mathole, Portfolio Manager at Novare.
Hedge fund assets by size
Total net outflows for the industry in 2018 were R15 billion as hedge fund assets declined to R47 billion.
The industry continued to be dominated by large hedge funds with assets over R2 billion. They represented 42% of total hedge fund assets after growing by a further 4% since Novare’s review of the industry in 2017.
However, funds with assets between R500 million to R1 billion, and R1 billion to R2 billion, lost industry share, with the latter category dropping from 25% to 14% of total hedge fund assets. Consequently, this led to increased market share for funds with assets below R500 million and those with assets over R2 billion.
Small net inflows were observed in only two areas – R1.87 billion in the categories of hedge funds with assets between R100 million and R200 million as well, as R1.69 billion in funds managing less than R100 million. Outflows were experienced in all categories of funds with assets under management (AUM) between R500 million and R2 billion, with the largest asset losses in the R1 billion to R2 billion category. The least net outflows (R1.5 billion) were observed in funds with an AUM of between R200 million and R500 million.
“In the past, the proliferation of South African hedge fund assets happened without significant inflows to the industry. This infers that growth, in terms of assets, was mostly driven by good returns,” said Mathole.
Average performance by fund size
All fund categories by size delivered positive returns on average for the 12-month period ending 31 December 2018. Within each category at least 50% of funds achieved positive returns despite headwinds.
“A number of macro-economic factors negatively impacted fund performance in 2018. These were less supportive for emerging markets with the International Monetary Fund (IMF) citing several risks for these economies,” said Mathole.
Risk factors included the prospect of central banks in developed economies raising interest rates, and the adverse impact of the US-China trade dispute on global economic growth. Other institutions, including the World Bank, held the same view regarding global risk factors, which led to the downward revision of global growth forecasts. Subsequently, South Africa’s growth forecast was also downgraded from 1.4% to 1%.
Local bond yields drifted higher as the rand reacted negatively to budget projections for 2019 and inflation remained within the SARB’s target band. Local equities ended the year on a volatile note as global growth concerns, geopolitics and uncertainty over trade policy sent markets gyrating. Local equities fell in line with global sentiment, bringing the year’s losses to a negative 8.53% on a total return basis, as per Iress data.
On average, funds managing more than R2 billion of assets posted an annual return of 2.7%, while the performance of funds with less than R100 million was flat.
Management and performance fees
“Investors are placing greater emphasis on hedge fund fee structures, with the issue of fees having come to the fore in recent years. Constantly under regulatory scrutiny, hedge fund investors are increasingly concerned about the impact of fees on investments, especially during times of muted returns. In a climate of subdued returns, investors often opt to scale down on fees and invest in passive strategies,” said Mathole.
Despite these pressures, there was a spike in fund managers charging annual fees of between 1.25% and 1.5% in 2018. There was a slight decrease in funds charging 1%, while those charging 2% per annum dropped significantly.
However, performance fees did see some changes in approach. Approximately 87.0% of funds charge a performance fee of 20%, denoting a 6% decrease from 2017, with 75% of managers employing a cash plus hurdle.
Notably, managers charging a 15% performance fee doubled to 10.9% in 2018 with more managers considering a hard hurdle. There has also been a rise in ‘other’ performance fee hurdle rates not previously viewed as ‘traditional’ hurdle rates.
In 2016, almost no funds instituted a cap on performance. However, in 2017, 17.1% of funds reported having a cap on performance fees. Based on the 39 hedge fund managers that responded to this question in the survey, the number of funds that apply a cap on performance fees dropped to 5.6% for the 2018 calendar year.
Pressures around fees, especially when performance is negative, coincided with the new regulation requiring hedge funds to disclose their Total Expense Ratios (TER).
Respondents cited fee pressures as one of the main headwinds facing the industry during the period.
Mathole said Novare remained optimistic about growth prospects for the industry as hedge funds remain an effective alternative tool for risk mitigation and portfolio diversification. “Last year was undoubtedly difficult for the industry. However, looking ahead survey participants expect flows to increase into 2019.”
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