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JOHANNESBURG — Sygnia CEO Magda Wierzycka‘s announcement that her firm is closing all its hedge-fund products after a 13-year long strategy has sparked quite the debate in the industry. In a piece she wrote for Business Day, Wierzycka slammed hedge funds for becoming a “management-fee racket”. In her article, she also said that in closing Sygnia’s hedge fund products, her company has also “fired all hedge fund managers and hopefully closed a chapter on this form of investing”. She also cited the rise of passive or index-tracking investments as shining a closer spotlight on the hedge fund industry’s performance and fees. In response to Wierzycka, hedge fund manager Jean Pierre Verster has written an interesting pointed piece on how he thinks recent developments have actually made the space more challenging for middle-men players, a sign of possible healthy disruption. Take a read. – Gareth van Zyl
By Jean Pierre Verster*
I recently shared the stage with Magda Wierzycka during a series of seminars which intended to give level-headed insight into the topic of land expropriation, where we attempted to separate fact from fiction and discussed the widespread misunderstanding regarding that emotive topic. Similarly, Magda’s opinion piece in yesterday’s Business Day offers me an opportunity to engage with her on a public stage once more, to respond rationally to some strongly held beliefs regarding hedge funds.
When referring to ‘hedge funds’, it is important to note that the concept refers to any fund that employs leverage, mostly via shorting transactions. This includes long/short funds that operate in equity, fixed income and commodity markets, whether domestic, regional or global. It is a very broad industry, which means that criticising it on average is akin to knocking down a straw puppet. A generalisation too broad to be relevant. So, let’s hone in on some of the specific criticisms:
1. Hedge funds charge astronomical fees
The typical fee structure of a 1% basic management fee and 20% performance fee (if a cash hurdle is exceeded) would only be ‘astronomical’ in the case where the fund delivers an astronomical return. That is the whole point of a performance fee – the investor only pays up for performance, aligning the interest of the investor with the manager. Almost all hedge funds employ a high-water mark, which guards against charging a fee just for making up previously lost ground.
The more accurate criticism would be that hedge fund-of-funds are at risk of charging unreasonable fees. This is due to the fact that, for a period of overall average performance, when half of a fund-of-funds’ underlying investments into single-manager funds do above-average and the other half do below-average, the fund-of-funds would incur performance fees on half the portfolio, plus add their own layer of fees, leading to a very costly investment proposition for the hedge fund-of-funds investor, relative to the average underlying return pre-fees. A hedge fund-of-funds would attempt to only pick above-average hedge fund managers in order to avoid this outcome.
2. Hedge funds have, on average, not performed well over the past few years
The last few years have indeed been difficult for most domestic equity market participants, on average, including equity-centric hedge funds and long-only funds. The FTSE/JSE All Share Index has returned 4.8% over the past 12 months (total return to 14 August 2018), and roughly 6% per annum over the past 2, 3 and 4 years. Year-to-date, the index is down 1.6%. Some hedge funds have done better than this, and some worse.
Criticising the average performance delivered by a heterogenous industry doesn’t contribute to better understanding – one should rather assess whether the persistency of outperformance of the best performers are random, or whether it implies skill. This goes for hedge funds, long-only funds and even individual shares (the skill of a company’s management team). Expecting outperformance by an individual fund for every single calendar year is also not realistic, but many long-running domestic hedge funds have admirable long-term track records of beating the market, after all fees. Prospective hedge fund investors would find the monthly disclosure documents available from the websites of all the major hedge funds useful in this regard.
3. Regulation and transparency are bad for the hedge fund industry
On the contrary, being allowed to now market directly to the public and giving pension fund trustees comfort regarding the mitigation of non-market risks when investing in hedge funds is a development that will benefit both the hedge fund industry and hedge fund investors.
The first hedge fund to be added to a major linked investment service provider (LISP) platform happened just last week, and the expectation is that many more hedge funds will be available on all the major LISP platforms soon, a crucial distribution channel for financial advisors and retail investors alike. The Association for Savings & Investment SA (ASISA) is also busy finalising the classification guidelines for hedge funds, which would allow for proper performance comparisons between different types of hedge funds, given their disparate mandate restrictions. Total expense ratios and investment charges are already required to be disclosed by hedge funds on their monthly disclosure documents, and performance is always quoted after these fees and charges.
Another consequence of more stringent regulation is that the past value proposition of a traditional hedge fund-of-funds is somewhat obsolete. Fund-of-funds used to vet the legal structure of unregulated hedge funds, the operational risks of the business, the methodology of fees being charged, the appointment of third-party service providers and the validity of the pricing of funds. All of this is now covered by regulation. It has been a painful transition for most hedge fund-of-funds to reinvent their business model or to stop offering the product altogether, as Sygnia has chosen to do. That is the nature of disruption, when middle-men get squeezed out of the value chain.
- Jean Pierre Verster is a hedge fund manager