24 October 2013Hedge funds have earned their place as valuable components in Australian retail investor portfolios, according to Jarrod Brown, Bennelong Funds Management Chief Executive Officer.
Jarrod said that hedge funds, which are commonly used by institutional investors as diversification and risk management tools, can provide similar benefits to retail investors, when selected carefully.
“According to independent data from research firm Australian Fund Monitors (AFM), which tracks over 208 Australian-offered hedge and absolute return funds via their Equity Fund Index, hedge funds actually outperformed the S&P/ASX 200 Accumulation Index over a 10 year period,” he said. “In fact, from January 2003 to June 2013, the AFM Equity Fund Index returned 11.53% compared with 9.22% from S&P/ASX 200.”
Jarrod said that even more importantly, the equity based funds outperformed with less risk, which is something that many investors may not have expected.
“When the usual measure of risk, standard deviation was calculated for the two indices, the AFM Equity Fund Index came in at 7.88% p.a, whereas the S&P/ASX 200 was 13.41% p.a. - significantly higher,” he explained.
As measured by Sharpe Ratio, investors received more than twice as much reward for each unit of risk if investing in the AFM Equity Fund Index as opposed to the S&P/ASX 200 Accumulation Index.
Jarrod said that while it is true that the Australian hedge fund sector as a whole outperformed, retail investors still need to consider how the underlying strategies and risk exposure of specific funds meet their individual needs.
Not all hedge funds are inherently risky, but investors do need to understand the risk/return profile of the specific fund they are considering. The Bennelong Long Short Equity Fund, for instance, which adopts a relatively low-risk ‘neutral pairs’ trading strategy, has achieved 21.81% in the last 12 months (as at 30 September). Since inception, the Fund has earned positive returns every year, including an 11.95% return in calendar year 2008 and 20.6% in calendar year 2011, both of which were negative years for the S&P/ASX 200.
Similarly, Kardinia Capital manages Bennelong's second hedge fund, The Bennelong Kardinia Absolute Return Fund has delivered investors 14% per annum over seven years. This 'variable beta' (which means the manager has the flexibility to adjust the Fund’s exposure to the underlying market) strategy has ensured a positive return in every calendar year since inception in 2006. This obviously includes the heart of the Global Financial Crisis in 2008 when the Fund returned positive 0.30% whilst the market fell close to 40%.
“Clearly, some hedge funds can both generate and protect wealth,” Jarrod said.
Nonetheless, and despite these dual benefits, some Australian retail investors are still averse to investing in hedge funds, with concerns focused on the structure of the funds, and in particular fees and liquidity.
Jarrod said that when it comes to fees, transparency is a regulatory requirement in Australia – there are no hidden surprises; investors know exactly what they will be paying.
“The good news is that the AFM data shows that Australian hedge funds are generally cheaper than offshore-based funds,” he explained. “The average fee charged on funds in the AFM database was 1.3% p.a for management, whereas the typical formula for overseas funds is ‘2 plus 20’, which means a 2% management fee and a 20% performance fee if performance hurdles are met.”
With respect to performance fees in Australia, the average was 13%, much lower than the 20% typically charged overseas.
“And it’s important to remember that performance fees are only charged when specific performance hurdles are met or exceeded,” Jarrod explained.
When it comes to liquidity, this does vary from fund to fund. While the Australian market is more heavily regulated than the US market, investors do need to do their homework. While some funds will have a minimum investment of $500,000 and monthly unit prices, the Bennelong Kardinia Absolute Return Fund, for example, has an initial investment of $20,000, a minimum withdrawal of $10,000 and daily unit prices.
Jarrod concluded by saying that a growing number of research houses, financial planning groups and investment platforms have expressed confidence in hedge funds for Australian retail investors, which in turn has increased interest and access to the funds.
For example, the Bennelong Kardinia Absolute Return Fund has been rated by a number of researchers and made available via several platforms including Macquarie Super Wrap, BT Wrap, Asgard, Netwealth and Wealthtrac, as well as being added to the manager line-up of Colonial’s fund-of-fund offering, FirstChoice Lower Volatility Australian Share Fund.
“Hedge funds might not be suitable for everyone – and their structures, strategies and risks certainly require additional research and understanding on the part of advisers and clients alike,” he said. “But the reality is that the best hedge funds can provide outstanding performance with significantly lower volatility than traditional managed funds.”