Hedge Funds: An Uncharted Goldmine

Published on 12th September 2007

In today’s investment maze, guaranteed low return is good enough, and that explains why most investors will opt for speculation at the equity market to any other investment option. In the larger world of fund management, big enough is good enough. Most investors will opt for managed funds that are diversified to the extent that market volatilities as often as they strike, do not spell doom on the client’s investment. 

Typically, a majority of high end investors in the market today are more familiar with mutual funds.  Although mutual funds offer the advantage of expertise in composite selection, the return may not be guaranteed and the approach is more pegged to the long term. 

Hedge funds, which are similar to mutual funds, have turned a couple of millionaires around the world into billionaires. Hedge funds are aggressively managed and use advanced investment strategies such as leverage, long, short and derivative positions in both domestic and international markets with the goal of generating high returns. 

They are mostly set up as private investment partnerships open to a limited number of investors and require a very large initial minimum investment.  If Emerging Africa Capital (EmAC) for example was to set up a hedge fund valued at USD 10million (Kshs. 700million), the firm would be required to do a private placement to roll out the fund.  This, as per the Kenyan laws, would require the company to place the product not to more than one hundred single applicants (whether individual or corporate). If numbers go above the one hundred, is considered public and therefore done through a secondary market with the approval of Capital Markets Authority (CMA). 

Hedge funds mostly comprise of the principal person investing huge amounts of cash in the fund. Typically, the principal firm will invest over 40 percent or an anchor investor puts in a similar amount. Hedge funds are very illiquid as they require investors to keep their cash for at least one year.  This is however similar to the mutual funds whose investment approach is geared towards the long term.

Normally, hedge funds are not regulated as they cater for sophisticated investors. One need not get a license from the CMA to set up a hedge fund in the country.  However, the fact that they have previously not operated in the country would call for close monitoring mainly by regulatory authorities - CMA and the Central Bank of Kenya (CBK).

In the United States (US), law requires that investors in a hedge fund be accredited, that is, they must earn a minimum amount of money annually and have a networth of over $1million along with a significant amount of investment knowledge. Think of hedge funds as mutual funds for the super rich.

In Kenya, some investment schemes claim to give a monthly yield of over 10 percent.  Most of them claim to be investing in equities locally and internationally (that is yet to be confirmed).  Such a formation is an ideal set up for a hedge fund.  In such a case, investors would invest a minimum of say Kshs. 5,000,000. The investment would then yield over 100 percent per annum but also with the risk of -100 percent.

Hedging is typically the practice of reducing risk. The goal is always to maximize returns.  The risks involved stem from embarking on a very speculative strategy. If a dealer takes Kshs.5,000,000 and trades the amount, alongside 5 other similar amounts from different clients’ money, would that be called a hedge fund?  Although the trading may not be defined as a hedge fund due to lack of a legal framework, the practice qualifies in its nature. 

Sadly though, hedge funds have grown at the expense of mutual funds.  In Kenya for example, where we have close to 15 fund managers, the annual return for most mutual funds stands at between 12 percent and 25 percent.  This is very low compared to a speculative strategy applied on an equal amount of funds.  The expertise in a hedge fund is higher and degree of risk tolerance very high.

It’s because of this that experts have argued that mutual funds should be managed by people who also manage hedge funds.  The motivation for this is that fund managers receive a lot more pay when funds perform very well. 

As a way of comparison, mutual funds unaffiliated with hedge funds perform better than those that operate side by side with hedge funds.  Please note also that side by side mutual funds generally receive significantly lower portion of low priced shares of IPO's than hedge funds.

If initiated, investors, especially the high net worth will need to seriously consider on what to opt for hedge funds or the mutual funds. Given that the hedge fund will generate more return; one will rarely go to his fund manager to ask for a current statement of ones investment composites, except on the aspect of insider information. There are also greater risks over the collapse, and in this case, neither your principal investment nor the returns are guaranteed. In addition, one could argue that the current mood in the economy marred by multiple pyramid/ponzi schemes and broker malpractices does not warrant a hedge fund. 

But again, the market is ripe for a hedge fund and the experts have what it takes.  Perhaps the packaging counts, and as far as that is concerned, we already have a package. This could be the new route that will shape the size of our transactions at the bourse.      


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