Optimising a portfolio of hedge funds in South Africa

Abstract

The South African hedge fund industry is reported to have had R52 billion (USD 4.8 billion) assets under management at the end of December 2013. This compares to the global industry which is reported to have surpassed USD 2.6 trillion at the end of 2013. Due to the relative infancy of the local industry, little research exists to analyse the performance of South African hedge fund strategies. This study focuses on the performance of South African hedge fund strategies under different market regimes, taking into consideration market and economic factors specific to South Africa. The analysis shows that the hedge fund strategies offer a diversification benefit to more traditional asset classes, and the results of the study can be used to inform an investor’s allocation decision. The findings of the analysis are used as the basis of a portfolio construction framework for constructing a portfolio of hedge funds. The framework is predicated on the investor having a view on the forthcoming macro environment. The framework enables the investor to identify funds and strategies that have produced a stable alpha over a similar market regime for inclusion in the portfolio of funds. After identifying those funds and strategies most suited to the anticipated macro environment, the number of funds to be included in the portfolio is taken under consideration to determine the optimal number such that the performance and risk characteristics of the portfolio are not compromised. The analysis takes the higher moments of the distribution into account to cater for the non-normal nature of hedge fund distributions.