A growing number of market analysts are now convinced the bull market of the previous 20 years has drawn to a close, and institutional fund managers are rethinking their investment strategies to accommodate what may be a protracted downturn.
This explains the proliferation of hedge and absolute return funds - which seek to generate positive returns whether markets, are rising or falling.
"The performance of the average long-only fund over the last two years has been dismal, and fund managers are having to rethink their investment strategies in light of changed market conditions," says Declan O`Brien, Head of Sales in Cape Town for Global Trader 247, the leading international Contracts for Difference (CFDs) pioneers.
O`Brien says the phenomenal growth in the hedge fund industry, now believed to be worth $600 billion worldwide, is a measure of investor fatigue with the traditional long-only investment style. The long-only investment approach presumes asset prices will rise over the long-term, and is suitable only in bull market conditions. This worked well in the 1990s when asset prices shot well above historic valuations, but many analysts now believe the constant bull market is over.
"Most forward-looking fund managers are developing alternative investment vehicles, which allow them to profit whether markets are rising or falling," says O`Brien. "This is why CFDs are proving increasingly popular among institutional fund managers."
CFDs, while relatively new to SA, are well established in the UK. Last year they accounted for up to 30% of turnover on the LSE. CFDs are margin-traded instruments, which means traders can buy exposure to market movements using only a fraction of the capital required in the cash market. The ability to leverage allows fund managers to hedge against market downturns at relatively little cost.
Investors can trade over a 100 different local and international instruments, from shares to precious metals, currencies, bonds, interest rates and indices, all off a single platform provided by Global Trader 247. They can go long (buying in expectation of a price rise) just as easily as going short (seeking to profit from an expected drop in price). CFDs differ from other types of investments in that the investor never takes ownership of the underlying asset. All the investor is buying, is the movement in price of the underlying asset. And, unlike warrants which are subject to time decay and other price distortions, CFDs track the movement in the underlying asset price in a predictable way.
O`Brien says one of the major attractions of CFDs is their flexibility, allowing fund managers to develop creative hedging strategies. For example, assume you want to buy Billiton but are uncomfortable with its exposure to oil. You can go long (buy) Billiton and short (sell) Sasol, thereby stripping out the oil exposure by profiting on Sasol should it fall.
One strategy adopted by some gold fund investors is to go long un-hedged gold producers and short the heavily hedged ones to maximise the profit from any expected rise in the gold price. This is costly if done via the JSE, as the fund manager must put up the full cash cost for the shares. Not so with CFDs. The strategy can be exercised using a fraction of the capital costs required on the JSE, thereby generating a much larger potential return on profit. This is particularly appropriate for talented fund managers with smaller funds under management.
Global Trader 247 recently opened an office in Cape Town to service its growing client base among the institutional fund managers there. O`Brien says the expansion to Cape Town is partly a response to the rapid development of alternative investment funds by traders and fund managers fed up with the restrictions of large institutions, and the attendant fear of job security due to the ongoing consolidation among financial institutions.
Hedge funds have been slow in coming to SA, but are likely to proliferate over the next few years, as investors bale out of long-only funds in an effort to protect their savings from further market erosion. There are a variety of different types of hedge funds, but all seek to protect funds under investment from uncertainty. The oldest type of hedging strategy is the long/short strategy, where the fund manager goes long one asset and shorts another. For example, assume two companies are due to report their financial results. The fund manager expects good results from one company, which happens to be under-valued, and bad results from the other, which is over-valued. He would then buy the under-valued and sell the over-valued in an effort to profit from the expected rise in price in the one and the fall in the price in the other.
The problem is that these kinds of strategies are costly if done via the share market, particularly for retail investors. "With the introduction of CFDs, these restrictions are taken away as the CFD provider takes all these costs onboard as with the risk management, funding and settlement costs," says O`Brien.
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