Not Every Brown Bear is a Grizzly – Just as Not All CIS Funds Are Alike

Grizzly bears, a subspecies of the brown bear, may appear akin to their cousins, yet subtle variations in size, diet, and behavior provide them with distinct advantages. This analogy can also be drawn to hedge funds.

While hedge funds are categorized as a type of collective investment scheme (CIS), their operational dynamics differ significantly from conventional long-only funds – and these distinctions are crucial. Grasping how hedge funds function, as well as why they were historically challenging for individuals to access, clarifies their increasing value as an investment tool today.

Much like the grizzly bear, renowned for its agility, adaptability, and resilience, hedge funds possess unique characteristics that set them apart for good reason.

Let’s delve into how this distinction is relevant for you as an investor.

Hedge funds: Uniquely structured

In 2015, hedge funds were officially recognized as CISs under the Collective Investment Schemes Control Act (Cisca). This regulatory change enhanced transparency and accessibility.

However, just as the grizzly bear can’t be defined solely by its classification as a brown bear, hedge funds transcend the typical CIS characterization. Their behavior and foundational design create meaningful differences.

A broader array of tools – diversifying returns while safeguarding your capital

As grizzlies seek a diverse diet by foraging beyond the coast, hedge funds utilize a wider range of investment strategies.

While long-only unit trusts generally adopt a buy-and-hold strategy – investing in shares, bonds, and property – hedge funds employ a comprehensive toolkit aimed at capital protection and return generation in both bullish and bearish markets.

These include:

• Short selling: Profiting during asset price declines.
• Options and derivatives: Instruments for risk management and return enhancement.
• Event-driven and special situations: Strategies that capitalize on temporary market inefficiencies.
• Pair trading: Profiting from performance disparities between similar companies.

Why this is important

Hedge funds are not restricted to following market trends. They adjust to various market conditions, similarly to how a grizzly adapts its behaviors to changing environments – offering greater flexibility and consistency for investors.

Prioritizing absolute returns over mere index outperformance

Most traditional funds aim to outperform an index – even if that index is declining.

Conversely, hedge funds adopt a different mindset by concentrating on absolute returns, seeking to grow your wealth irrespective of the broader market’s performance.

Why this matters

Your financial aspirations should be evaluated in real terms – actual currency – not just relative metrics. Like a grizzly preparing for winter, hedge funds focus on outcomes that hold significance in real life: safeguarding and increasing capital under all circumstances.

Minimal correlation with traditional assets – true diversification

Grizzlies do not follow the same patterns as their coastal counterparts, and hedge funds do not invariably mirror the movements of equities or bonds.

Why this is vital

In volatile markets, hedge funds can serve as buffer agents. Their low correlation with traditional asset classes contributes to smoother returns and enhances your portfolio’s resilience during downturns.

Previously difficult to access – now available to individual investors

Spotting a grizzly in the wild once required a costly expedition to North America. Similarly, gaining access to hedge funds used to necessitate institutional-level connections or complex investment strategies.

Today, that landscape has shifted.

Why this is important

Hedge funds, such as those at Peregrine Capital, are now reachable through all major linked investment service provider (Lisp) platforms. They have become essential for adept financial advisors who understand the value hedge funds can bring to their clients. Enhanced accessibility and significantly lower minimum investments entail that private investors can now tap into strategies historically reserved for institutions and professional asset managers.

Compact industry size – focus and agility

Grizzlies flourish in specific environments where nimbleness and concentration are essential. Similarly, hedge funds in South Africa comprise a relatively small industry (around R80 billion compared to over R2 trillion in long-only CIS), which can work to their advantage.

Why this is important:

Smaller fund managers often exhibit greater agility. They can swiftly capitalize on overlooked opportunities and evade the risks associated with larger institutions’ activities, offering investors specialized knowledge.

Why should this matter to you?

Because hedge funds are constructed differently, they behave differently – leading to the potential for superior outcomes:

• More stable returns
• Enhanced protection against downturns
• Effective diversification
• Access to top-tier strategies
• Alignment with tangible financial objectives

In a marketplace characterized by escalating volatility and complexity, hedge funds represent a more adaptable and resilient investment strategy. They are no longer the exclusive domain of the extraordinarily wealthy – and they are increasingly playing a pivotal role in contemporary portfolios.

PS: No bears were harmed in the creation of this article.

Waldo Booysen is an investment specialist at Peregrine Capital.

Peregrine Capital (Pty) Ltd is an authorized financial services provider.

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