Risk management strength of hedge funds

“A true hedge fund is an investment vehicle with a primary key to minimise investment risk in an attempt to deliver profits under all circumstances.”

“A true hedge fund is an investment vehicle with its primary key to minimise investment risk in an attempt to deliver profits under all circumstances.”

Such was the definition of a hedge fund at Absolute Capital managing director Deon Joubert’s hedge fund presentation, delivered to delegates at the recent 10th National FPA convention.

The hedge fund specialist shared a number of approaches and strategies to the alternative asset class, saying the key behind hedge funds is risk management.

“There is no real magic. It’s mostly risk management. There are between 8,000 and 10,000 hedge funds worldwide, and most have offshore tax structures. With so many of them, the trick is to pick the best ones,” Joubert says.

Hedge funds can be either hedged or directional, Joubert says, with directional being the riskier strategy of the two since it involves betting on the direction of the market. Hedge funds can take either a top down or bottom up approach, depending on the two motivations of increasing returns or reducing risk.

While the top down approach is the easiest method for smaller portfolios, the bottom up approach is still a few years away from popular use as a strategy, according to Joubert.

Due to the heavy weighting on the importance of risk management for hedge funds, Joubert says planners should look to the specialist managers for hedge fund products.

“It isn’t everyone who can do this. Using specialists will protect capital,” he says.

Because risk characteristics are different, Joubert says it is important to understand where the returns come from and to be realistic about making profits.

“It is not about shooting out the lights and getting 40 to 50 per cent,” Joubert says.

The common law of investing — diversification — also rings true for hedge funds, and Joubert says risk can be protected with a broad portfolio.

“Hedge funds blow up just like stocks blow up. Hedge funds are a different type of product and not for everyone,” he says.

“They are a new asset class, all about investigation and diversification, and may or may not suit a type of client and portfolio.”

But a fundamental problem with hedge funds remains, that they need longer market exposure than the traditional asset classes.