HEDGE FUNDS: PROTECTING RETIREMENT FUND RETURNS

Although seen largely as risky and speculative, hedge funds act as an 'insurance policy' if used appropriately

- ATLEHA-EDU

In July 2022, National Treasury published new regulations pertaining to the maximum allocation retirement funds can make to certain asset classes, including hedge funds.

Following the amendments to Regulation 28 of the Pension Funds Act in July 2022, retirement funds are allowed to allocate up to 10% of their capital to hedge funds. The maximum allocation to a single hedge fund is 2.5%, while that of a fund of hedge funds is 5%.

Previously, hedge funds were grouped together with private equity funds as an asset class.

Pros and cons

The change in allocation limits allows for retirement funds to get the full benefit that hedge funds typically offer, including: 

Portfolio diversification: Hedge funds may offer low correlation to traditional equity and fixed-income markets. In other words, when the equity markets decline sharply, a low-correlated hedge fund could perform better or even deliver positive returns.

Reliable returns: Hedge funds are structured to outperform markets in times of volatility, due to their low correlation to traditional assets, and especially during market downswings.

There are also some pitfalls to consider:

Fees: Management and performance fees are typically higher than normal unit trust fees. This is due to the more complex strategies employed by these funds, with their accompanying higher expenses.

Lock-in: As hedge funds are not limited to which assets they are allowed to invest in, these may typically include unlisted assets. The latter cannot be readily traded, as is the case with listed equities, which results in a 'lock-in' of some of the fund's underlying capital. The fund manager bridges this liquidity issue by placing a restriction on when money can be withdrawn-typically monthly or quarterly for large investors.

What is hedging?