Hedge fund articles often come wrapped in layers of jargon – and to be fair, there’s a reason for that. They don’t follow the same playbook as traditional investments (like buying shares, bonds, or listed property). They use different tools, different strategies, and require a deeper understanding.

In the spirit of keeping it simple, let’s start with an analogy. Think of your portfolio as a rugby team. You’ve got your defenders – cash and bonds – to provide stability and stop you from losing ground. Your loose forwards, like listed property, help control the pace. And then there are your back line – equities – who go for the big plays and score the points.

Hedge funds? They’re the all-rounder players – strategic, versatile, and able to switch roles when needed. They’re not always front and centre, but when the game gets unpredictable, they can adapt quickly, plug gaps, and help secure the win.

In South Africa, Regulation 28 of the Pension Funds Act allows for up to 10% exposure to hedge funds in retirement portfolios. It’s a small allocation, but one that can bring real balance to the mix when used wisely.

What is a Hedge Fund?

A hedge fund is a pooled investment vehicle managed by professionals who use a wide range of strategies to generate returns. Unlike traditional unit trust funds, which typically only invest in assets expected to rise in value (like buying shares to hold), hedge funds can take both long and short positions, use derivatives, and hedge risk exposures.

They aim to deliver “alpha” – returns above the general market – by capitalising on inefficiencies and opportunities that traditional funds might be unable to access or invest in. Globally, hedge funds have a reputation for catering to high-net-worth individuals, but in South Africa, they’re much more accessible and strictly regulated under the Collective Investment Schemes Control Act (CISCA).

The power of flexibility

What sets hedge funds apart in a balanced portfolio is their flexibility. They aren’t constrained to simply ride the market wave. They can navigate around it, take advantage of falling prices, or mitigate specific risks.

This means they may generate positive returns even in downturns – making them valuable tools for smoothing out volatility and enhancing risk-adjusted returns over time. In simple terms: while shares can make your portfolio soar and bonds can protect the downside, hedge funds can do a bit of both, depending on the market environment.

Regulation 28 and the 10% limit

Let’s be clear: the 10% cap on hedge funds in retirement portfolios is not a red flag. It’s a guardrail. Regulation 28 aims to ensure that your core portfolio remains familiar, liquid, and relatively low-risk.

But within that 10%, hedge funds are given the space to operate differently – to seek uncorrelated returns that can complement traditional holdings. In times of market stress, that difference may be exactly what helps your portfolio remain resilient.

Considerations and misconceptions

Like any tool, hedge funds need to be used appropriately. They often come with performance fees, meaning managers get paid more when they outperform. While this can align interests, investors should ensure fees are transparent and tied to real results.

And then there’s the perception problem. Thanks to Hollywood and some global scandals, hedge funds carry a reputation for high risk and exclusivity. But that image doesn’t reflect the South African market, where hedge fund managers are FSCA-licensed, regulated, and held to high standards of transparency and governance.

Benefits of Hedge Funds

Hedge funds have distinct advantages when integrated with traditional investments:

• Diversification: Hedge funds invest in various assets and strategies, reducing overall investment risk and potentially increasing returns.
• Higher returns: They employ diverse strategies that can lead to higher returns, especially during market volatility or when traditional assets perform poorly.
• Active management: Hedge funds are actively managed by experienced professionals who adapt to market conditions for potentially better performance.
• Lower correlation: They often have lower connections to traditional assets, adding more diversification to a portfolio.
• Access to alternatives: Hedge funds offer access to unique investments like commodities and currencies, enhancing diversification and return opportunities.

Hedge funds aim to deliver asymmetric returns by generating positive performance across varying market conditions. Rather than simply tracking the market, they use strategies designed to participate in gains during upswings while limiting losses during downturns. This approach offers a more consistent return profile and serves as a powerful risk management tool – helping to protect capital when markets fall, without missing out on potential upside when they rise.

Exhibit 1 | Asymmetric returns in hedge funds

For illustrative purposes only and not indicative of any investment.

A valuable addition

Hedge funds aren’t about replacing traditional assets. They’re about adding a strategic player to your team that no one sees coming – until the last-minute try that wins the game. In a diversified portfolio – particularly for retirement – even a small allocation to hedge funds could help protect capital, reduce volatility, and enhance long-term returns.

So next time you think about a balanced portfolio, don’t just focus on your star players. Sometimes it’s the adaptable all-rounder team member – and not the headline act – that holds the line, fills the gaps, and keeps the whole team performing under pressure. Hedge funds might not be the fly-half or the lock, but they could be the game-changer that keeps your strategy on track when the match gets tough.