Could hedge funds save the day in times of uncertainty?

In a volatile market, where global policies can shift overnight and currencies fluctuate daily, hedge funds can
provide a powerful tool for investors looking to stabilise returns and capture opportunities that traditional
strategies might overlook.

Once seen as exclusive and complex, hedge funds might actually provide stability when markets are shaky.
As hedge funds become more regulated, transparent and accessible, particularly in South Africa, financial
advisers and investors are starting to recognise the value they can bring to a diversified portfolio.
While the local market remains underdeveloped, largely due to limited awareness and persistent myths around
hedge funds, the question is no longer whether hedge funds belong in portfolios, but how best to use them.

The origins of hedge funds: why understanding the history matters

Hedge funds have come a long way since 1949 when sociologist and financial journalist, Alfred Winslow
Jones, first combined long and short stock positions to reduce market risk – essentially “hedging” his
bets. His pioneering approach outperformed traditional funds and introduced the now-familiar approach
to hedge fund management and performance fee structuring.

While strategies have evolved, the principles remain the same: harnessing skill, insight, flexibility and
innovation to deliver returns in all market conditions. These principles matter now more than ever. In a
world defined by volatility (and in a local market seeking diversification and downside protection) hedge
funds offer tools that traditional investments often can’t.

Understanding the origins of hedge funds helps investors and advisers better grasp why these have
become such a powerful addition to modern portfolios, including ones here, in South Africa.

Not all hedge funds are the same: what you need to know

The term “hedge fund” is often used in investing, but there’s no universal definition, which can leave
people puzzled. While “hedging” suggests protecting capital and reducing risk, that may not always be
the case, as not all hedge funds aim to explicitly reduce risk. Some hedge funds are designed to take
on more risk in order to maximise the probability of achieving outsized returns.
Hedge fund managers can employ various strategies to achieve the end goal. Hedge funds can short
sell, use leverage to amplify returns, or they can make use of derivatives to manage risk. So, are hedge
funds about getting rich fast, or are they a more stable option? The answer could be both, or neither.
Complex, indeed!

Here are some common hedge fund strategies to help you better understand how they work:

• Equity long/short: This strategy involves buying stocks expected to outperform and shorting
those expected to underperform, with the overall position reflecting the manager’s market view.
• Market-neutral: This strategy balances long and short positions to neutralise market swing risk
(beta), allowing managers to focus solely on picking the right stocks, regardless of market
direction.
• Global macro: These funds focus on broad economic trends such as interest rates, currencies
or commodities across various asset classes.
• Fixed income arbitrage: These funds take advantage of small price discrepancies in fixed
income markets and often use leverage to amplify returns.

In South Africa, popular strategies include equity long/short, fixed income arbitrage, multi-strategy and
market-neutral approaches.

Understanding a hedge fund manager’s strategy is key before deciding if it’s the right fit for your
portfolio. As legendary investor Jesse Livermore said: “There is only one side of the market and it
is not the bull side or the bear side, but the right side of the market.”

Why should financial advisers and investors pay attention to hedge funds?

Hedge funds aren’t just speculative toys; they’re a versatile tool in a well-rounded portfolio. They can
provide true diversification, often behaving differently from equities and bonds, which can help protect
portfolios during market downturns. They also help as managers tactically adjust allocations to reflect
dynamic economic shifts. And for those looking to add some extra return, certain hedge fund strategies
can amplify overall returns without significantly increasing risk. These factors can result in a portfolio
that’s both defensive and opportunistic – a powerful combination for investors.

The growing appeal of hedge funds for South African investors

South Africa's hedge fund market is small, covering approximately only R185 billion in assets within the
massive R3.87 trillion collective investment scheme sector. However, the industry is growing rapidly,
with net inflows for 2024 reaching a record R11.8 billion, according to ASISA, and nearly double the net
inflows in the previous two calendar years.
Since the FSCA introduced regulations in 2015, hedge funds in South Africa have become more
accessible to both retail and institutional investors. These regulated structures, like retail investment
hedge funds (RIHF) and qualified investment hedge funds (QIHF), now allow access to hedge funds
for pre-retirement (Regulation 28), post-retirement and in their discretionary investments across linked
investment service provider (LISP) platforms. With the Collective Investment Schemes Control Act
(CISCA) now overseeing them, hedge funds are treated as regulated collective investment schemes,
offering investors greater transparency and enhanced risk-control measures.
As hedge funds continue to gain popularity, financial advisers are increasingly recognising their
potential for delivering uncorrelated returns and capturing upside opportunities, making them a valuable
tool for diversifying and strengthening client portfolios.

Where to from here?

South African hedge funds are gaining traction thanks to stronger regulation, growing investor familiarity
and innovative domestic managers. These funds are more accessible and valuable than ever. In a world
where volatility is the only constant, hedge funds are no longer a “black box”. They’re a versatile “Swiss
Army knife” for building resilient portfolios. Ready to rethink your portfolio and improve risk-adjusted
returns? We think it’s a Sharpe idea.

How do you charge for investment advice?

A client's question to consider- by Rob Macdonald

I know of many professionals such as engineers, lawyers, accountants and doctors who have never engaged the services of a financial planner. Some have looked after their financial affairs well, others not. One such professional recently sought my counsel as she considered working with a financial planner for the first time.

She spent 30 years doing her own financial planning, but with retirement looming, decided to seek professional financial advice and consulted me on her choice of financial planner. Not knowing the financial planner in question, I did some research and gave the thumbs up. I liked the financial planner’s flexible approach to charging fees, depending on the service sought. In this instance, the client wanted help in reviewing her affairs and advice on any changes to legal structures and existing investments. The financial planner did a thorough job and charged a once-off fee for the work done. The client was happy with the work done and the fee charged.

The financial planner’s recommendations were implemented, and the client was happy but she recognised that there may be value in engaging the financial planner’s services on an ongoing basis. The client asked the financial planner to quote for such a service, with a primary focus on the client’s investments. The financial planner quoted for the ongoing service at a 0.25% fee charged as a percentage of assets under advice. This proposal was the catalyst for the client to seek my counsel for a second time. Their dilemma was not about whether they wanted to work with the financial planner (they did), but rather about the way the fee was being charged. The client had three questions in this regard. The first question was, “Is this standard practice for financial planners?” “Yes,” was the easy answer. She then asked, “Why?”

This question was a little trickier to answer. Her query related to the fact that the investments were being managed by various fund managers who were charging asset-based fees, so she wondered why the financial planner charged in the same way given that they don’t manage the money. I explained that the financial planner would provide ongoing oversight of the assets and by charging an asset-based fee, the financial planner’s interests were completely aligned with that of the client as the fee rises or falls according to the value of the assets. While the client understood this, she didn’t accept it because of her third question.

She explained that she had spent 30 years saving and investing her earnings as a medical professional to achieve a portfolio of significant value, and now the financial planner was proposing to take an asset-based fee on the full value of the portfolio, despite having not been involved with its accumulation. Her third question was, “Why does the financial planner take a fee on the initial value?” The easy answer was that this is industry practice. But I knew that this would not suffice. After much discussion, we agreed that what she needed to do was agree with her financial planner what the “ongoing service” would involve and that she should ask for a “retainer fee” with the financial planner.

To appease her concerns, the fee needed to be disconnected from the value of her portfolio, which she felt was the product of her hard work. They came to an agreement on this basis. But I remain uncomfortable that I could not answer her question adequately. Why is it standard practice for a fee to be charged on all the assets that a client already has in their investment pot? Is there a legitimate explanation that it is in the best interests of the client? Or is it simply standard practice because few clients question it?

• BC Article link: https://bluechipdigital.co.za/southern-africa-financial-planning-journal/thought-leaders/how-do-you-charge-for-investment-advice/
• Ebook link: https://www.yumpu.com/en/document/read/69790026/blue-chip-issue-94/18

Addressing key risks in a retirement portfolio.

Retirement is a life event that brings about mixed emotions. Many individuals in South Africa approach it with excitement, others with anxiousness and uncertainty.- by Marius van der Merwe, Chief Executive Officer, Amity Investment Solutions

One of the challenges advisors face when preparing and managing a client’s retirement plan is to reduce the risk of the client running out of money during their retirement years. Some of the questions advisors often grapple with are:

1. What if the client lives longer than the typical life expectancy?
2. What if the client retires during a great financial crisis or a pandemic?
3. How much growth assets and offshore exposure should the portfolio hold?
4. How do you manage market risk in the portfolio?

Our research focused on developing strategies to address two key considerations when managing a portfolio for retirement:

Sequence risk

While sequence risk is not as important in the accumulation phase of a client’s investment journey, it can make or break them financially, and emotionally, during the decumulation phase. Clients retiring at the start of a bull market often have a much better investment experience than those starting their retirement journey just before a major market correction or an adverse event like the COVID-19 pandemic.

But what can you, as a financial advisor, do to reduce sequence risk? Our research shows that appropriate asset allocation, based not only on long-term returns but also on incorporating different risk criteria, is critical in constructing a decumulation portfolio. Secondly, continuously applying tactical asset allocation based on the valuation of asset classes is one of the best strategies to mitigate sequence risk. However, implementing this requires a portfolio mandate specifically developed and managed for retirement investing. That’s why we believe an outcomes-based investment strategy implemented through building blocks is appropriate for this purpose.

Ruin probability

The second consideration is longevity. In 2022, South Africa had the largest elderly population in its history. Living longer may be wonderful, but it also means your retirement portfolio needs to last longer. Therefore, when constructing a portfolio for retirement, the ruin probability should be considered. Ruin probability refers to the likelihood of a retirement portfolio being unable to provide the income required for the specified investment horizon. Our research found that ruin probability can be reduced through appropriate asset allocation. However, the optimal mix of growth assets and offshore exposure is affected by the portfolio withdrawal rate.

Our research found that at a 5% withdrawal rate, the ruin probability can be reduced to less than 5%. It is also interesting to note that at this withdrawal rate, the ideal portfolio requires fewer growth assets and less offshore exposure – the main drivers of risk in a portfolio – than expected. As indicated in the table above, the exposure to growth and offshore assets increases as the withdrawal rate increases. However, increasing these assets does not mitigate the ruin probability. At a 7% withdrawal rate, a client has a 33% probability of running out of money before the 30-year investment horizon.

Findings like these indicate that constructing a retirement portfolio entails more than selecting the right funds; it requires portfolio design based on defined financial and behavioural outcomes.

• BC article: https://bluechipdigital.co.za/featured/addressing-key-risks-in-a-retirement-portfolio/
• Ebook link: https://webkiosk.globalafricanetwork.com/blue-chip-issue-92/68764570/62

At Matrix, the dynamic evolution of economic data - especially in relation to consensus expectations -
is a fundamental component of our investment philosophy. Economic information influences decision making
across three primary pillars of our process: security pricing, asset allocation, and risk
management. Recognising that financial markets are inherently forward-looking, we understand that
asset prices - across equities, bonds, and currencies - largely reflect anticipated economic and policy
developments. These expectations are continuously shaped by forecasts from analysts, economists,
central banks, and corporates.

Our goal is not only to assess where the economy currently stands within its cycle, but to identify
potential divergences from consensus narratives. Economic surprises - whether positive or negative -
can materially shift market pricing, creating both risks and opportunities. To navigate this complexity,
we focus particularly on three key segments of macroeconomic data: (1) economic conditions, (2) price
developments, particularly inflation trends, and (3) fiscal considerations. Each of these areas provides
critical input into our investment framework.

Economic Conditions: Business Cycle Positioning and Growth Signals

Understanding economic conditions begins with assessing a blend of leading indicators and hard data.
Leading indicators such as purchasing managers’ indices (PMIs), business and consumer confidence
surveys, and vehicle sales offer forward-looking insights into momentum in various sectors. These are
complemented by hard data points - GDP growth, employment figures, retail sales, manufacturing
production, and mining output amongst others - which serve to confirm or challenge these early
signals.

This segment of economic data plays several roles in our investment process:

•Macro Assessment:
It helps determine the current phase of the business cycle - expansion, slowdown, recession, or recovery - which in turn frames our macro outlook.

•Asset Allocation:
We adjust exposure across asset classes depending on cyclical dynamics. For example, stronger growth may warrant greater allocation to equities and cyclical sectors, while slowing activity may shift preferences toward defensive assets, bonds, or cash.

•Foreign vs Local Positioning:
Changes in growth prospects affect terms of trade and capital flows, guiding us in selecting the most appropriate local versus offshore exposures.

•Security Pricing Models:
Economic growth data are incorporated into valuation models for bonds and equities. For instance, bond fair value models include GDP and country risk spreads, while equity models incorporate expected earnings based on macro growth trajectories.

•Risk Management:
By using these data points to develop both base-case and alternate economic scenarios, we obtain a more granular understanding of the distribution of potential outcomes. This allows for more informed and resilient risk budgeting in the asset allocation process.

Example: A persistent rise in PMIs above 50 suggests strengthening economic momentum. This would likely lead us to increase exposure to equities and adjust earnings expectations upward, consistent with a constructive growth outlook.

Price Developments and Inflation Trends: Monetary Policy Signals and Market Impact.

The second critical dimension of our analysis focuses on price developments, particularly inflation. Here, we monitor headline and core Consumer Price Index (CPI) data, Producer Price Index (PPI) levels, and inflation expectations—both survey-based and market-derived (e.g., breakeven inflation rates). Additionally, central bank communication and monetary policy guidance are closely scrutinized to understand the policy trajectory and its implications.
Price data informs our strategy in the following ways:

•Monetary Policy:
Forecasting: Inflation trends and policy signals help to assess whether current monetary conditions are too tight or too loose. Anticipating policy rate changes is crucial in understanding shifts in capital markets.

•Asset Allocation Strategy:
Inflation dynamics have a major influence on positioning along the yield curve. For example, accelerating inflation may prompt a shift to shorter-duration bonds and increase allocations to inflation-linked instruments. In equities, this might shift preferences between growth (long duration) and value sectors.

•Foreign Exchange Strategy:
Inflation differentials and policy responses inform our FX positioning. Weak responses to high inflation typically lead to currency depreciation, especially in emerging markets.

•Risk Management:
Inflation uncertainty is often hedged through derivatives - such as interest rate swaps or inflation-linked instruments - and factored into scenario analysis to ensure robustness under varying inflation regimes.

Fiscal Considerations: Sovereign Risk and Portfolio Calibration

The third pillar of our process involves analysing fiscal dynamics. Key metrics include government budget balances, public debt-to-GDP ratios, primary balances, and the composition of debt financing (e.g., local vs foreign currency; short- vs long-term maturities). The fiscal impulse, or the change in net government spending and taxation, is also a significant indicator of demand-side influence on growth and inflation.
Fiscal data is integrated into the investment process through several channels:

•Sovereign Risk Assessment:
Deteriorating fiscal health, especially if debt sustainability is in question, may elevate credit risk and impact local bond yields.

•Asset Allocation:
Fiscal trends help determine the relative attractiveness of local bonds versus offshore developed market instruments, and influence the broader balance between equities, bonds, and cash.

•Currency Risk:
Persistent fiscal imbalances can undermine investor confidence, trigger capital flight, and lead to currency weakness, necessitating careful currency management.

•Credit Metrics and Valuation:
Fiscal indicators feed directly into bond valuation models, including our assessments of credit ratings, CDS spreads, and fair value bond pricing.

•Risk Management:
Fiscal vulnerabilities may require currency or interest rate hedging strategies and prompt re-evaluation of local versus foreign asset exposure. They may also alter our duration strategy, especially if financing risks begin to affect the yield curve

At Matrix, economic data is not just background noise - it is an essential input into how we price securities, structure portfolios, and manage risk. By continuously evaluating and challenging consensus expectations with real-time economic outcomes, we seek to identify early signals of change and respond proactively. Whether through macroeconomic indicators, inflation data, or fiscal metrics, our investment process is designed to adapt to a constantly evolving economic landscape while maintaining a disciplined approach.

- END -

About the author
Lourens Pretorius has over 30 years’ experience in financial markets and is an executive director and co-chief investment officer at Matrix Fund Managers, heading up the fixed income team. He manages a key strategy in the fixed income hedge funds and is a FAIS key individual and authorised representative.

Disclosure
Matrix Fund Managers Pty Ltd is an authorised Financial Services Provider (FSP 44663), licensed for Category I, II and IIA services in terms of the Financial Advisory and Intermediary Services Act.

Any forecasts or market commentary, whether express or implied, are not guaranteed to occur and may change without notification at any time after publication. All reasonable steps have been taken to ensure the information in this article is accurate. The information does not constitute financial advice as contemplated in terms of the Financial Advisory and Intermediary Services Act. Use or reliance on this information is at your own risk. Independent professional financial advice should always be sought before making an investment decision.